ACO        1081 


MODERN   BUSINESS 


THE  PRINCIPLES  AND  PRACTICE  OF  COMMERCE, 
ACCOUNTS  AND  FINANCE 


PREPARED  AND  EDITED  UNDER  THE  DIRECT  SUPERVISION 

OP 

JOSEPH  FRENCH  JOHNSON,  A.B.,  D.C.S. 

DEAN  NEW  YORK  UNIVERSITY  SCHOOL  OF  COMMERCE,  ACCOUNTS  AND  FINANCE 
AUTHOR  "MONEY  AND  CURRENCY,"  "SYLLABUS  OF  MONEY  AND  BANKING,"  ETC. 


MONEY  AND  BANKING 


A  DISCUSSION  OF  THE  PRINCIPLES  OF  MONEY  AND 

CREDIT,  WITH  DESCRIPTIONS  OF  THE  WORLD'S 

LEADING  BANKING  SYSTEMS 


BY 
EARL  DEAN  HOWARD 

PROFESSOR  OF  FINANCE  IN   NORTHWESTERN  UNIVERSITY  SCHOOL  OF  COMMERCE; 
AUTHOR  OF    "  INDUSTRIAL  PROGRESS  OF  GERMANY  " 


IN  COLLABORATION  WITH 

JOSEPH  FRENCH  JOHNSON 

DEAN  OF  NEW  YORK  UNIVERSITY  SCHOOL  OP  COMMERCE,  ACCOUNTS  AND  FINANCE  ; 
AUTHOR  OF  "  MONET  AND  CURRENCY,"    "  THE  CANADIAN  BANKING  SYSTEM,"  ETC. 


MODERN  BUSINESS 

VOLUME  V 


DE  BOWER-ELLIOTT  COMPANY 

CHICAGO— NEW  YORK 


COPYRIGHT,  1910 

BY 

DE  BOWER-BLLIOTT  COMPANY 


fflWVERSITY  OF  SOUTHERN  CALIFORNIA 


EDITOR'S  PREFACE 

This  volume  discusses  questions  in  which  the  American 
people  have  been  forced  by  events  to  take  a  deep  and 
personal  interest.  The  rise  of  prices  and  resultant  in- 
crease in  the  cost  of  living  since  1897  have  provoked  uni- 
versal discussion  and  even  called  forth  proclamations  of 
disapproval  from  mayors,  governors  and  other  public 
men.  The  panic  of  1907,  which  caused  the  temporary 
suspension  of  cash  payments  by  many  banks  in  the 
United  States,  is  now  recognized  to  have  been  mainly 
due  to  the  defects  of  the  American  banking  system.  It 
is  doubtful  if  any  other  scientific  questions  have  been 
the  subject  of  so  much  popular  debate  as  those  which 
are  treated  in  this  volume  on  Money  and  Banking. 

It  goes  without  saying  that  no  man  is  fit  to  plan  the 
digging  of  a  tunnel  or  the  construction  of  a  railroad,  to 
mend  a  clock  or  repair  an  automobile,  unless  he  has  had 
a  certain  amount  of  scientific  training.  In  mechanics 
the  world  recognizes  the  need  and  practical  value  of 
science.  In  finance  the  same  need  exists,  but  it  is  not 
yet  generally  acknowledged.  Everybody  thinks  he  un- 
derstands the  money  question,  or  that  it  is  not  worth 
understanding,  and  the  average  man  is  inclined  to  think 
that  the  business  of  banking  is  so  simple  that  if  our 
banks  have  in  any  way  fallen  short  of  their  duty,  the 
men  who  manage  them  must  either  be  very  ignorant  of 
their  business  or  very  selfish  and  speculative  in  their 
methods. 

As  a  matter  of  fact,  the  science  of  money  and  credit, 


EDITOR'S  PREFACE 

while  almost  as  exact  in  its  nature  as  mathematics,  is 
one  of  the  most  difficult  in  the  whole  field  of  economics, 
and  the  business  or  profession  of  banking,  which  is 
founded  upon  that  science  and  should  be  conducted  in 
accordance  with  its  principles,  is  one  demanding  the 
keenest  and  clearest  brain.  Industry  furnishes  the  red 
blood  of  the  economic  organism.  Trade  and  commerce 
are  its  circulatory  system.  Finance  is  its  nervous  sys- 
tem. If  the  banker  is  incompetent  and  fails  in  the  per- 
formance of  his  task,  the  entire  business  world  is  para- 
lyzed. 

In  the  present  volume  the  effort  has  been  made  to 
give  the  reader  in  the  clearest  possible  language  a  scien- 
tific knowledge  of  money  and  credit  and  an  accurate 
description  and  analysis  of  the  various  banking  systems 
with  which  the  world  is  now  having  experience.  The 
subject  is  difficult  and  no  reader  can  expect  to  get  en- 
lightenment from  this  book  unless  he  is  willing  to  think 
as  he  reads.  If  he  will  do  that,  I  feel  certain  that  he 
will  quickly  grasp  all  the  principles  expounded  and  in 
the  end  discover  that  many  business  problems  which 
have  perplexed  him  have  been  made  easy  of  solution. 

The  editor  cannot  too  strongly  advise  that  this  volume 
be  read  carefully  by  the  general  business  man.  The 
banker,  of  course,  should  understand  the  subject.  If 
he  does  not,  he  is  conducting  his  business  by  rule  of 
thumb,  and  is  courting  disaster.  But  the  business  man 
should  not  think  that  Money  and  Banking  are  matters 
with  which  he  is  not  concerned.  On  the  contrary,  they 
treat  of  matters  which  immediately  concern  him.  The 
relation  of  money  to  the  upward  and  downward  swings 
of  prices  is  something  which  the  average  business  man 
does  not  perceive,  yet  it  is  something  which  he  ought  to 
understand,  for  his  prosperity  often  depends  on  causes 


EDITOR'S  PREFACE 

affecting  merely  the  demand  for  and  supply  of  money. 
The  prices  of  commodities  are  merely  an  expression  of 
the  value  of  money  and  they  change  whenever  money 
changes.  The  business  man  who  knows  only  the  con- 
ditions which  govern  the  value  of  the  commodity  which 
he  handles  is  only  half  protected  against  loss.  If  he 
would  be  safe  he  must  know  also  the  conditions  which 
determine  the  value  of  money. 

JOSEPH  FRENCH  JOHNSON. 
New  York  University. 


TABLE  OF  CONTENTS 


PART  I:     MONEY. 

CHAPTER  I. 
FUNDAMENTAL  ECONOMIC  CONCEPTS. 

SECTION  PAGE 

1.  Reasons  for  the  Study  of  Money  and  Banking  ...  1 

2.  Warnings  of  the  Late  Panic 3 

3.  Science 3 

4.  Finance 3 

5.  Technology  and  Business 4 

6.  Business  the  Result  of  Specialization  of  Labor  ...  5 

7.  Production 5 

8.  Production  by  Change  of  Ownership 6 

9-     Tardy  Recognition  of  Value  of  Exchange   ....  7 

10.  Private    Property 8 

11.  Property  and  Wealth 8 

12.  Integration   of    Industry 10 

CHAPTER  II. 
EXCHANGE. 

13.  Beginning    of    Exchange 11 

14.  Barter 12 

15.  Money 12 

16.  Money   Represents   Incomplete   Exchanges    .      .      .      .  13 

17.  Credit 14 

18.  Credits  as  Media  of  Exchange  ...          ....  15 

19.  Money  and  Credit  Representatives  of  Wealth    .      .      .17 

20.  Classification    of    Wealth 18 

21.  Entrepreneur  System 19 

22.  Capital 20 

23.  Capitalization 21 

vii 


viii  MONEY  AND  BANKING 

SECTION  PAGE 

24.  Demand   for   Capital   Goods 23 

25.  Money  Incomes 23 

26.  Methods    of    Investment 24 

27.  Real     Investment 25 

CHAPTER  III. 
VALUE. 

28.  Value  a  Register  of  Economic  Forces    .....  27 
29-     Meaning  of  "  Value  " 28 

30.  Definition  of  the  Dollar 29 

31.  Exchangeability  the  Sole  Utility  of  Money  ....  29 

32.  Gold  not  an  Ideal  Standard 29 

33.  Determination    of    Value 31 

34.  Utility  Theory  of  Value 31 

35.  Marginal    Utility 32 

36.  Marginal  Utility  to  the   Individual 33 

37.  Reconciliation  of  the  two  Theories 34 

CHAPTER  IV. 
EVOLUTION  OF  THE  MEDIUM  OF  EXCHANGE. 

38.  Primitive  Ideas  of  Value 35 

39.  Ornamental  Stones  Early  Used  as  Money    ....  36 

40.  Three   Functions   of   Primitive   Money 36 

41.  Wampum 36 

42.  Beaver    Skins 37 

43.  Agricultural  Products  as  Money 38 

44.  Tobacco 38 

45.  Summary    of    Principles 40 

46.  Divisibility 41 

47.  Uniformity 41 

48.  Cognizability 42 

49.  Stability  of  Value 42 

CHAPTER  V. 
EVOLUTION  OF  THE  STANDARD  OF  VALUE. 

50.  Metal  Standards  the  Fittest  to  Survive 44 

51.  Good  Qualities .44 


CONTENTS  ix 

SECTION  PAGE 

52.  Platinum  Unsuccessful  as  Money  ..........  45 

53.  Objections  to  Gold  and  Silver 45 

54.  Coinage 46 

55.  Names  of  Coins 46 

56.  Requirements  of  Good   Coinage .47 

57.  Standard  of  Value 48 

58.  Double  Standard  Possible  Until  Last  Century  ...  49 

59.  Gresham's  Law 50 

60.  Mistakes  of  Early  Legislators 51 

61.  Experience  of  England  with  Double  Standard  ...  52 

62.  Adoption  of  Single  Gold  Standard  Unintentional   .      .  53 

63.  Mintage 54 

64.  Legal  Tender  ...          55 

65.  History  of  Coinage  in  the  United  States 56 

66.  First  Ratio  of  Silver  to  Gold  15:1    .      .     ..      .      .      .  56 

67-     Inaccuracy  of  the  Ratio  and  its  Effects  .      .      .      .      .  57 

68.     Disappearance  of  the  Silver  Dollars 58 

69-     Change  of  Ratio  to  16:1 60 

70.  Legal  Tender  Acts  Created  a  Paper  Standard  60 

71.  Single  Gold  Standard  after  1879 61 

72.  Act  of  1900 62 

73.  Summary 62 

CHAPTER  VI. 
STANDARD  OF  DEFERRED  PAYMENTS. 

74.  Defects    of   Gold 64 

75.  Definition  of  Deferred  Payments 65 

76.  Effect  of  Legal  Tender  Laws 66 

77.  Constitutionality  of  Legal  Tender  Acts 66 

78.  Debtor  Class  Injured  by  an  Appreciating  Standard  .      .  68 

CHAPTER  VII. 
SUPPLY  AND  DEMAND  IN  RELATION  TO  MONEY. 

79-     Price 69 

80.  Prices  Depend  Upon  the  Money  Market 70 

81.  Utility  of  Money 71 

82.  Distinction  Between  Desire  and  Demand 71 


x  MONEY  AND  BANKING 

SECTION  PAGE 

83.  Three  Varieties  of  Money 72 

84.  Fiat  v.  Credit  Money ,«     .  72 

85.  Demand  for  Money  Analyzed 73 

86".  Rapidity    of    Circulation 73 

87.  Effect  of   Population 73 

88.  Effect  of  Division  of  Labor 74 

89.  Special  Demand  for  Gold 75 

90.  Payment  of  Contracts  ..........  75 

91.  Store  of  Value 75 

92.  Insecurity  of   Property  and  Contracts    .      .      .      .      .76 

93.  Special  Demand  for  Money  as  a  Store  of  Value  ...  76 

94.  Hoarding 77 

95.  Decline  of  Hoarding 77 

96.  Bank  Reserves  not  Hoards  . .,     .      .  78 

97.  Government  Hoarding  ........      ..     ,.  78 

98.  Discrimination  in  Demand  for  Money    .......  79 

99-  Seasonal  Demand  for  Money 80 

100.  Demand  for  Money  in  International  Trade  ....  80 

101.  Premium  on  Gold 81 

102.  Uncertainty  of  the  Demand  for  Money 81 

103.  Supply  "of  Money .      .  82 

104.  Varieties   of   United   States   Money 82 

105.  Supply  of  Gold 83 

106.  Factors  in  the  Supply  of  Gold   .......  83 

107.  Peculiarity  of  the  Supply  of  Gold 84 

108.  Historical  Illustrations 84 

109.  Temporary  Results  of  Change  of  Money  Supply  .      .      .85 

110.  Effect  of  Increased  Supply  of  Gold  Traced  Out  .      .      .  86 

111.  Limit  to  the  Price-Raising  Effect  of  Gold  ....  87 

112.  Alternative  Uses  of  New  Gold    .......  87 

113.  Widespread  Effect  of  New  Gold  .......  88 

114.  Comparison  of  Effect  of  Increase  of  Supply  of  Gold  and 

Paper  Money 89 

115.  How  Much  Money  is  Needed  in  a  Country?  ....  90 

116.  Price  Changes  not  Synchronous 91 

117-  Stimulating  Effect  of  Rising  Prices 91 

118.  Reaction 92 

119.  Swings   of  Prices    .      .   „ 92 

120.  Cumulative  Effect  of  Economic  Forces   .      ....  93 


CONTENTS  xi 

CHAPTER  VIII. 
THEORY  OF  PRICES. 

SECTION  PAGE 

.121.     "  Short "  Sales  of  Money ,    ,..    ...     ,..     95 

122.  "  Squeezing  the  Shorts "    .      .      .      ....     ..,     .      .     ..     95 

123.  Forced  Selling ...     96 

124.  People   Becoming  Better  Educated    .      .      .,     ...     ...     .     96 

125.  General   Price   Level 97 

126.  Price     Tables 97 

127.  Many  Commodities  .      .      .      .      .      .      .,     .      .      .      .97 

128.  Example  of  Price  Table   .      ....     ,.,     ,.,     ,.,     .     98 

129.  "Weighting"   of   Price   Tables    .      .      .      .,.,...     99 
ISO.     Advantages  of  Weighting 100 

131.  Falkner   Price   Table ...   100 

132.  High  Prices  During  the  Civil  War 104 

133.  Foreign  Price  Tables   .      .      .      :      .      .      ....      .106 

134.  Economic  Forces  to  be  Observed  ..     ,.,    ,.,     .   107 

135.  Saving  and  Investing ,.,     .      .      .      .   109 

CHAPTER  IX. 
DOMESTIC  AND  FOREIGN  EXCHANGE. 

186.  Relation  Between  Foreign  and  Domestic  Exchange  .      .   112 

137.  Payments  by  Means  of  Credit  Balances  .      .      ...      .112 

138.  Function  of  the  Bank  in  Making  Payments  .      .  .113 

139.  Payments   at  a  Distance    .      .      .      .,     .      .      ...      .113 

140.  Exchange  on  New  York 114 

141.  How  the  Banks  Handle  New  York  Exchange   .      .      .115 

142.  Settlement  of  Accounts  Between  Banks 116 

148.     Cost  of  Currency  Shipments 117 

144.  Settlements  Through  the  Sub-treasuries 117 

145.  Rate  of  New  York  Exchange 118 

146.  Significance  of  Rates  of  Domestic  Exchange  .      .      .      .119 

147.  The   Clearing    House    Principle 121 

148.  Settling  Balances  by  Use  of  Credit 122 

149.  Gold  the  International  Medium 122 

150.  Function  of  the  Dealer  in  Foreign  Exchange  .      .      .      .123 

151.  Example  of   Foreign   Exchange 123 

152.  Why  Bankers  are  Willing  to  Purchase  Foreign  Drafts  .    124 

153.  Progress  of  Draft  .      .      .      ., 125 


Xll 

SECTION  PAGE 

154.  Quotations   for   Foreign   Exchange 125 

155.  The  Pound  Sterling 125 

156.  Cost  of  Shipping  Gold 126 

157.  The  Minimum  Gold  Point  for  Sterling  Exchange   .      .  127 

158.  Maximum  Gold  Point  for  Sterling  Exchange    .      .      .127 

159.  Why  Sterling  Exchange  May  Fall  Below  $4.8465   .      .128 

160.  The  Gold  Market 129 

161.  Bank   of    France 130 

162.  Gold  Shipments 131 

163.  Our    Foreign    Commerce    ....      . 131 

164.  Invisible   Items   of  Foreign   Trade 132 

165.  Movements  of  Capital 133 

166.  Interest  and  Dividend  Payments  to  Foreign  Stockholders  134 

167.  Freight    .................  134 

168.  Tourists  .     ,.,     ,.,     .,     .      .      .      .....      .      .      .  134 

169-  Foreign  Exchange  Market  .      .     t.,    ,.,     .     ,.,     ,.      .      .  135 

170.  Explanation   of   Articles ...     ..      .      .136 

171.  Cables 136 

172.  Varieties  of  Foreign  Exchange 138 

173.  Demand    Sterling 138 

174.  English  Banking  Customs .      .      .139 

175.  Finance    Bills 140 

176.  Profit   on   Finance   Bills .,     .      .  141 

177.  Foreign  Department  of  a  Bank 143 

178.  Traveler's  Letters  of  Credit 145 

179-  Commercial    Letters    of    Credit 146 

180.  Buying  Foreign  Exchange  for  Investment   .      .      .      .147 

181.  German  and   French  Exchange 149 

182.  Arbitrage      ...     .     ,.,     ....     ,.      .     ,.,    ,.,     .      .  152 

CHAPTER  X. 
PRODUCTION  OF  THE  PRECIOUS  METALS. 

183.  World's  Stock  of  Gold 153 

184.  History  of  the  Precious  Metals 153 

185.  The  Feudal  Period 154 

186.  Discovery  of  America 155 

187.  Effect  of  Silver  from  America 156 

1 88.  Increased  Circulation  of  Money   .......  157 


CONTENTS  xlii 

SECTION  PACB 

189.  Discovery  of  Gold  in  California 157 

190.  Effect  of  California  Gold 158 

191.  South    African    Gold 159 

192.  Production  of  Gold ..159 

193.  Origin  of  Gold 159 

194.  Sources    of    Gold 160 

195.  Improvements  on  Placer  Mining 160 

196.  Dredging       .      .      .      .    '- 161 

197.  Quartz  Mining l6l 

198.  The    Comstock    Lode 162 

CHAPTER  XI. 
BIMETALLISM. 

199.  Bimetallism    Defined     ........     ,.      .      .   164 

200.  Difficulties  of  Bimetallism 164 

201.  Advantages    of    Bimetallism 165 

202.  International  Bimetallism 166 

208.  Disadvantages  to  Commerce  of  Different  Standard  .      .166 

204.  Early  Attempts  at  Inflation 167 

205.  Demonetization  of  Silver   .      . 168 

206.  The   Latin  Union 169 

207.  Demonetization  of  Silver  by  the  United  States  .      .      .    171 

208.  The  Silver  Purchase  Acts 172 

209.  Sherman  Act  One  of  the  Causes  of  the  Panic  of  1893  .    172 

210.  Silver   Would   not   Circulate 174 

211.  Attitude  of  Banks  toward  Silver 175 

212.  Silver   Certificates , 175 

213.  Currency   Situation  in   1890 176 

214.  The  Treasury  Gold  Reserve .      .177 

215.  Repeal  of  the  Sherman  Act 178 

216.  Authority  to  Issue  Bonds .      .      .      .179 

217.  Successive   Issues   of   Bonds 179 

218.  Belmont-Morgan    Syndicate 180 

219.  Silver  Question  .      . 182 

220.  Origin  of  the  Free  Silver  Movement .183 

221.  Arguments  for  Free  Silver 184 

222.  Argument  to  the  Workingman 185 

228.     Arguments  of  Advocates  of  Gold 186 


XIV 

SECTION  PAGE 

224.  The  50-cent  Dollar ,„  „,  .  ,.,  186 

225.  Probable  Results  of  Free  Silver  .      .     ...  ..,  ,..  ...  .  187 

226.  The  Real  Debtor  Class ..:  >  :.  ...  189 

227.  Solution  of  the  Silver  Question    .      .     ...  ,.,  ...  ,..  ..  190 

228.  Gold  Exchange  Standard  in  Mexico  .      .  .  ,.,  ,..  .  191 


PART  II:    BANKING. 

CHAPTER  XII. 
NATURE    OF    CREDIT. 

229.  Origin  and  Kinds  of  Credits  .....,,.     ,.     ,.   193 

230.  Use  of  Credit  in  Industry  ......     ,.,     ,.,     .      .   194 

231.  Function  of  Commercial  Banking  .      .      .      ....      .195 

232.  Mortgages  and  Bonds  . ,.,     .      .    196 

233.  Example  of  Timber  Industry 196 

234.  Advantages  of  Timber  Bonds .      .198 

235.  Interest  Rates  on  Bonds 198 

236.  Long-time  Borrowing .      .199 

237.  Credit  Economizes  the  Use  of  Gold 199 

238.  Liquidation  of  Credit 200 

239-  Commercial  Paper  Houses  and  the  Credit  Situation  .      .   201 

240.  Use  of  Credit  as  a  Medium  of  Exchange 202 

241.  Bank     Credit 202 

242.  Deposit  Credit 203 

243.  Elasticity  of  Deposit  Credit 204 

244.  Gold  the  Basis  for  all  Credit  .........  205 

245.  Reserve 207 

246.  Effect  of  Reserve  Requirements   .      .      .      ...      .      .  207 

247.  Danger  of  Use  of  Credit  in  Panics   .      .      .     ,.,     .      .  208 

248.  Importance  of  Credit 209 

CHAPTER  XIII. 
EFFECT  OF  CREDIT  ON  PRICES. 

249.  Increasing  Need  of  More  Efficient  Money   .      .      .      .211 

250.  Effect  of  Non-Circulating  Credit 211 

251.  Cancellation  of  Credit  .  .   212 


CONTENTS  rv 

SECTION  PAGE 

252.  How  Lessened  Demand  for  Money  Causes  Rise  in  Prices  213 

253.  Effect  of  National  Bank  Notes   .      .      .      .      .      .      .213 

254.  Bank  Notes  and  Checks  Differentiated   .      ...      .      .214 

255.  Effect  of  Government  Credit  Money 215 

256.  Credit    and    Speculation 216 

257.  How  Speculation  May  Be  Both  Cause  and  Effect  of  a 

Rise    in    Prices 216 

258.  Defect  of  our  Currency  System  .      .      .      .      .      .      .217 

CHAPTER  XIV. 
GOVERNMENT   CREDIT   CURRENCY. 

259.  Classification  of  Government  Credit  Currency   .      .      .  220 

260.  Fiat   Money    Defined 220 

261.  Factors  Determining  the  Value  of  Credit  Money   .      .221 

262.  Risk  in  Free  Use  of  Credit  Money 222 

263.  Regulation  of  Credit  Money 222 

264.  Devices  to  Maintain  Value  of  Credit  Money  ....  224 

265.  Argument   for   Government  Credit  Money    ....  224 

266.  Difficulties  of  Adjusting  Supply 225 

267-  Prejudices  Against  Government  Credit  Money  Before 

1861 226 

268.     Financing  the  Civil  War .      .   226 

269-     Disadvantage  of  Government  Debt 227 

270.  Government   Debt 228 

271.  Demand   Debts  a  Weakness 229 

272.  Provisions  for  Retiring  Debt  .........   230 

CHAPTER  XV. 
ECONOMIC  FUNCTION  OF  THE  BANK. 

273.  Productive  Industries   Classified 231 

274.  Recapitulation  of  Fundamental  Principles    ....  232 

275.  Credit 233 

276.  Bank  a  Dealer  in  Credits 233 

277.  Banks  Supply  a  Medium  of  Exchange 235 

278.  Banking  is  a  Quasi-Public  Function 235 

279.  The  Bank  a  Distributor  of  Capital 236 

280.  Banking  Principle 237 


xvi  MONEY  AND  BANKING 

SECTION  PAGE 

281.  Double  Function  of  Commercial  Banks 237 

282.  Peculiar  Privilege  of  Bankers 289 

283.  Banks   Do   Not   Create   Capital 242 

284.  Source  of  Capital  and  Credit  of  Bank 243 

285.  Operations  of  a  Bank 244 

286.  Responsibility  of  the  Banker  for  Proper  Distribution  of 

Capital 245 

CHAPTER  XVI. 
DEPOSIT  CURRENCY. 

287.  Analysis  of  Credit 248 

288.  How  Credit  Promotes  Industry 249 

289.  Banks  Create  Credits 249 

290.  Bank  Credit  Preferable  to  Cash 251 

291.  Shifting  of  Bank  Credit  Without  Liquidation   .      .      .251 

292.  Similarity  of  Checks  and  Bank  Notes  .      .      .      .      .      .  253 

293.  Limits  of  Earning  Power  of  the  Bank 253 

294.  Difference  Between  a  Cash  and  Credit  Loan  ....  254 

295.  Cash  a  Precious  Commodity  at  Times 254 

296.  Problem  of  the  Reserve  of  Greatest  Importance  .      .      .  256 

297.  Lack  of  Cooperation  Causes  Banks  to  Lose  Reserves  .      .  257 

298.  Methods  of  Increasing  Reserves 257 

299.  Secondary  Reserve 258 

300.  Unreliability  of  Bonds  as  Reserves 259 

301.  Aldrich-Vreeland  Act 259 

CHAPTER  XVII. 
BANK  STATEMENT  —  RESOURCES. 

302.  Combined    Statement 260 

303.  Proof  of  the  Deposit  Currency  Theory 261 

304.  Double-Entry  System 262 

305.  Alterations  in  Value  of  Resources 263 

306.  Concealed    Assets 264 

307-     Loans  and   Discounts 264 

308.     Overdrafts 265 

309-     United  States  Bonds  to  Secure  Circulation   ....  266 

310.     United  States  Bonds  to  Secure  United  States  Deposits  266 


CONTENTS  xvii 

SECTION  PAGE 

311.  United  States  Bonds  on  Hand 266 

312.  Premiums  on  United  States  Bonds  .......   266 

313.  Bonds,  Securities,  etc '.      .....   267 

314.  Banking  House  Furniture  and  Fixtures 267 

315.  Other  Real  Estate  Holdings 267 

316.  Due  From  National  Banks 268 

317.  Due  From  Approved  Reserve  Agents     .      .      .      .      .   268 

318.  Checks    and   Other    Cash    Items  —  Exchanges    for   the 

Clearing  House 269 

319.  Bills  of  Other  National  Banks  .      .      .      ...      .      .269 

320.  Legal   Tender   Notes    .      .      .      .      .     ...      .      .269 

321.  Redemption   Fund    . 269 

322.  Due  From  the  United  States  Treasury   ...      .      .   270 

CHAPTER  XVIII. 
BANK  STATEMENT  — LIABILITIES. 

323.  Capital  Stock  Paid  In  .      . 271 

324.  Double  Liability  of  Stockholders 272 

325.  Surplus    Fund 273 

326.  Undivided   Profits 275 

327.  National  Bank  Notes  Outstanding 275 

328.  State  Bank   Notes   Outstanding 276 

329.  Individual     Deposits 276 

330.  United  States  Deposits  and  Deposits  of  United  States 

Disbursing  Officers 277 

331.  Bonds    Borrowed     .....      .      ...      .      .   277 

332.  Notes  and  Bills  Rediscounted 277 

333.  Bills    Payable    .      .      .      .      .      . 278 

334.  Certified  Check  ....„...'....   278 
385.     Cashier's  Checks  Outstanding 278 

CHAPTER  XIX. 
ORGANIZATION  AND  BUSINESS  OF  THE  BANK. 

336.  National  Banks 280 

337.  State  Banks 280 

838.  Private   Banks 280 

839.  Underwriting 281 


xviii  MONEY  AND  BANKING 

SECTION  PAGE 

340.  Trust    Companies    .      .      ...      .      .     ,.,     .,     .      .  282 

341.  Banking  Department    ........     ,.     ,.,     .  282 

342.  Deposits  of  Trust  Companies  ......     ...     .     ...     .  283 

343.  Trust  Department .     m     ...     A     .  283 

344.  Individual   Trusts 284 

345.  Corporate    Trusts 284 

346.  Savings  Banks 285 

347.  The  Organization  of  a  Bank .      .      .  286 

348.  Evolution  of  the  Bank ..,.,..  286 

349.  Stockholders 286 

350.  Directors 287 

851.  Considerations  Governing  Choice  of  Directors   .      .      .288 

352.  Briggs  v.  Spaulding 290 

353.  Ignorance  No  Excuse 29 1 

354.  Supplementary  Examinations  Necessary 291 

355.  Opinion  of  Comptroller  Ridgely 292 

356.  The   President 293 

357.  The  Cashier 293 

358.  Paying   Teller .294 

359.  Receiving    Teller 295 

360.  Note  TeUer 295 

361.  Discount  Clerk 296 

362.  Bookkeeping  Department 296 

863.  Laws  Relating  to  Collections 297 

364.  Liability  of  Collecting  Bank 299 

365.  Collection   of  Out-of-Town   Checks 300 

366.  English  Method  of  Country  Collections 301 

CHAPTER  XX. 
DEPOSITS  AND  DEPOSITORS. 

867.  General    Deposits 303 

368.  Special    Deposits 303 

369-  Safety  Deposit  Vaults 304 

370.  Inducements  to  Depositors 304 

371.  Difficulties  in  Establishing  a  New  Bank 306 

372.  Value  of  a  Banking  Connection 306 

373.  Kiteing   Checks   and   Drafts 307 

374.  Method  of  "  Kiteing  " 307 


CONTENTS  xix 

SECTION  PACK 

875.  Title  to  Deposited  Checks,  etc 308 

376.  Case  of  Disputed  Ownership  to  Deposited  Check  .      .  308 

377.  Accepting  Deposits  when  Insolvent  is  Criminal  .      .      .  309 

378.  Drawer  Released  from  Responsibility  After  Reasonable 

Time    . 309 

379-  Local     Banks 310 

380.  Holder  of  a  Check  Cannot  Sue  Bank 310 

S81.  Revocation 310 

382.  Insufficient  Funds 311 

383.  Forgeries 311 

384.  Post-Dating ...  311 

385.  Set-Off 312 

386.  When  a  Depositor  Fails,  His  Note  Not  Being  Secured  .  312 

387.  Advantage    to    Depositor 812 

888.  Set-Off  Makes  Failures  Appear  Worse 313 

389.  Illustration 313 

390.  Form  of  Note 318 

CHAPTER  XXI. 
LOANS  OF  THE  BANK. 

891.  Two  Qualities  Necessary  to  the  Making  of  a  Banker  .      .  315 

392.  Investment  Loans 315 

393.  Conditions  Under  Which  They  Are  Good  Banking  Loans  316 
894.  Industrial    Loans 316 

395.  Capital   Loans 318 

396.  Capital  Should  Come  From  Stock  and  Bond  Issues  .      .318 

397.  Mortgage    Loans 319 

398.  Loans  Reported  to  the  Comptroller 320 

899-  Demand  Loans  Have  Increased 321 

400.  Double-Name    Paper 321 

401.  Single-Name  and  Brokers'  Paper 321 

402.  Judgment  Note 323 

403.  Collateral  Note 323 

404.  Risk  in  Collateral  Loans 324 

405.  Usury  Laws 325 

406.  Call  Loans  Exempted 326 

407.  Loans  on  Open  Book  Accounts 327 

408.  Providing  Temporary  Capital  ........  327 


xx  MONEY  AND  BANKING 

CHAPTER  XXII. 
LOANS  AGAINST  COLLATERAL. 

SECTION  PAGE 

409-  Collateral  for  Bank  Loans 329 

410.  Merchandise  as  Collateral 329 

411.  Advantages  of  Good  Warehousing  Laws 330 

412.  Loans  on  Merchandise  a  Legitimate  Function  of  Banks  330 

413.  Statement  of  a  Bank  President 331 

414.  Law  of  Warehouse  Receipts 332 

415.  Uniform    Law 332 

41 6.  Risk  Involved  in  Loans  on  Warehouse  Receipts  .      .      .  333 

417.  Under  the   Present   Law 333 

418.  Issue   of   Receipts   Safeguarded 334 

419.  Protection  to   Holders  of   Receipts 334 

420.  Garnishment  not  Allowed 335 

421.  Penalty  for  Illegal  Use  of  Receipts 335 

422.  Transfer  of  Title  to  Lender 336 

CHAPTER  XXIII. 
CREDIT  DEPARTMENT  OF  A  BANK. 

423.  Credit  Department  of  a  Bank 337 

424.  Sources  of  Credit  Information 837 

425.  Credit  Agencies 339 

426.  Duties  of  Credit  Man 340 

427.  The  Commercial  Note-Broker 341 

428.  Change  in  the  Business 341 

429.  Demand  and  Supply  of  Commercial  Paper  ....  342 

430.  Areas  of  High  and  Low  Rates 343 

431.  Discount  Offer  by  Dealer 343 

432.  Credits , 344 

433.  Size  of  Notes 345 

CHAPTER  XXIV. 
HISTORY  OF  BANKING  IN  THE  UNITED  STATES. 

434.  Characteristics  of  Early  Banking 347 

435.  Relations    with    Government 347 

436.  Historical  Periods 348 

437.  Some  Early  Banks  .....     ...     .     ..„    ...     .      .      .  348 


CONTENTS  xxi 

SECTION  PAGE 

438.  Loaning  on  Bank   Stock ..,    ,.,     .   349 

439.  First  Bank  of  the  United  States .,     ,.,     .   350 

440.  Success  of  the  First  Bank ,.,     ..,     ,.,     ,.,  351 

441.  Opposition   to    Recharter ..,     .352 

442.  Second  Bank  of  the  United  States 353 

443.  Redemption  of  Notes  in  Specie 353 

444.  Mismanagement  of  the  Bank 354 

445.  Jackson  Opposed  to  the  Bank  .      ....     ..,     .      .      .355 

446.  State  Banking ,     . ,     .   356 

447.  Suffolk  Bank  System    .      .,     ..,     .     ,.,     .     ,.,     ,..     .      .   357 

448.  New  York  Systems  ......     ..,     .     ...     ...     .      .   359 

449.  Safety   Fund   System    ............   359 

450.  Bond  Deposit  System 359 

451.  Mistakes  of  the  System 360 

452.  Free  Banking  System  ...........   361 

453.  Experience  in  Other  States  .........   363 

454.  Indiana  and  Ohio   .      .      .      .,     .,     ...     .,     ,.,     ,.,     ...     .   363 

CHAPTER  XXV. 
NATIONAL  BANKING  SYSTEM. 

455.  The  National  Bank  Act 365 

456.  Market  for  United  States  Bonds  .      ., 366 

457.  Early  History  of  the  Act 366 

458.  Comptroller  of  the  Currency .367 

459-  Summary  of  National  Bank  Act 367 

460.  Circulating   Notes 369 

461.  Evils  of  the  National  Banking  System 370 

CHAPTER  XXVI. 
PRESENT  CONDITIONS  OF  BANKING  IN  THE  UNITED  STATES. 

462.  The  Development  of  Bank  Deposit  Currency  .      .      .      .371 

463.  Limitation  of  Deposit  Currency 372 

464.  Seasonal  Demands 373 

465.  Depletion  of  Reserves 374 

466.  Government   Deposits 374 

467.  Inelasticity 375 

468.  Expansion  of  Bank  Circulation 376 


xxii  MONEY  AND  BANKING 

SECTION  PACK 

469-  Lack  of  Unity  in  Our  System 377 

470.  Savings  Banks 877 

471.  Postal  Savings  Banks ,.  378 

472.  Guarantee  of  Bank  Deposits 378 

CHAPTER  XXVII. 
RELATION  OF  BANKS  TO  WALL  STREET. 

473.  Market  for  Securities  in  the  United  States   .      .      .      .381 

474.  Working  Capital  of  Dealers  in  Securities  .      .      .  .382 

475.  Details  of  the  Collateral  Loan 383 

476.  Certification ...   383 

477-  Restrictions  on  Collateral 384 

478.  Call  Loan  Rate 384 

479-  Responsibilities  of  the  Loan  Clerk 385 

480.  Undigested  Securities 385 

481.  Close  Relation  Between  Reserves  and  Prices  ....   386 

482.  Plan  for  Remedying  the  Danger  in  Redepositing  Re- 

serves   387 

483.  Commercial  Banks 387 

484.  Financial     Banks 388 

CHAPTER  XXVIII. 
BANKS  AND  THE  UNITED  STATES  TREASURY. 

485.  Responsibility  of  the  Secretary  of  the  Treasury  .      .      .  390 

486.  Treasury  Causes  Stringencies 391 

487.  Defective  Currency  Laws 393 

488.  Expedients  of  the  Secretary 393 

CHAPTER  XXIX. 
EUROPEAN  BANKING  SYSTEMS. 

•489.  Bank  of  England 395 

490.  Development  of  the  Use  of  Checks 896 

491.  Bank  Act  of  1844 398 

492.  Character  of  Bank  of  England  Note 399 

493.  The  Bank  of  England   Private    .      .      ....      .      .400 

494.  Banking  in  France 401 


CONTENTS  xxiii 

SKCTIOK  PACK 

495.  Bank  of  France ......   402 

496.  Deposit  Currency  Little  Used  .     , ,     .   403 

497.  Asset  Currency 403 

498.  Branches 404 

499-  Imperial   Bank  of  Germany 406 

500.  Influence  of  Government 406 

501.  Modeled  on  Bank  of  England 407 

502.  Reserves 407 

CHAPTER  XXX. 
CANADIAN  BANKING  SYSTEM. 

503.  The  Bank  and  the  Government 409 

504.  Security  of   Note  Issues 409 

505.  Redemption  Fund 410 

506.  System   Very   Elastic 411 

507.  Reserves 411 

508.  Branch    Banking 412 

509-  Canadian  System  in  Actual  Operation 413 

510.  Moving  the  Crops 414 

511.  Grain  as  Security 415 

512.  Fluctuations  in  Note  Circulation 41 6 

CHAPTER  XXXI. 
SUMMARY  OF   CURRENCY  AND   BANKING   PRINCIPLES. 

513.  Elasticity 419 

514.  United    States    Currency 420 

515.  Sub-Treasury  System 420 

516.  Reserves 421 

517.  Guarantee  of  Deposits 422 

518.  State  Banks  and  Trust  Companies 423 

519-  Unity  of  Action 424 

520.  Speculation 425 

521.  Credit    Necessary 426 

522.  Financial  and  Commercial  Banks 427 

523.  Function    of    Commercial    Bank 427 


MONEY  AND  BANKING 

PART  I:    MONEY 

CHAPTER  >I 

FUNDAMENTAL  ECONOMIC  CONCEPTS 

1.  Reasons  for  the  study  of  money  and  banking. — 
The  study  of  money,  currency  and  banking  is  necessary 
to  every  person  who  desires  a  thoroughgoing  knowledge 
of  business.  Every  one  who  has  to  deal  with  prices, 
whether  he  be  a  producer  or  a  consumer,  a  working  man 
selling  his  services  or  a  capitalist  receiving  interest  on 
his  investments,  in  order  to  conduct  his  affairs  intelli- 
gently must  understand  the  forces  affecting  prices  of 
the  commodities  or  the  services  in  which  he  is  inter- 
ested. Every  fluctuation  of  price  affects  the  welfare 
of  every  person  who  buys  or  sells,  and  the  ability  to 
foresee  these  fluctuations  enables  the  business  man  to 
avoid  loss  and  gain  profits. 

The  science  of  money  and  banking  deals  with  prices, 
and  attempts  to  explain  their  fluctuations  so  far  as  the 
cause  of  these  fluctuations  is  due  to  changes  in  the  con- 
ditions of  currency  and  banking.  The  influence  of  cur- 
rency and  banking  upon  prices  is  much  more  important 
than  is  generally  supposed. 

Every  business  man  understands  the  fluctuations  of 
price  that  are  brought  about  by  alterations  in  the  supply 
of  or  the  demand  for  commodities  or  services.  He 

VII— 1 


2  MONEY  AND  BANKING 

knows  when  five  men  are  bidding  for  one  article  that  the 
price  will  go  up,  and  that  when  five  sellers  are  offering 
their  goods  to  one  man  the  price  is  likely  to  go  down. 
He  is  not  likely  to  understand,  however,  how  prices  in 
general  may  go  up  in  consequence  of  a  new  discovery 
of  gold  in  the  Klondike  or  an  increase  in  the  amount  of 
bank  credit  outstanding.  Yet  these  latter  forces  are 
just  as  potent,  and  even  more  enduring,  than  the  former 
in  affecting  prices. 

To  offset  the  enormous  damage  chargeable  against 
the  panic  of  1907,  we  must  place  on  the  credit  side  of 
the  account  an  item  whose  importance  is  becoming  more 
and  more  apparent.  This  item  is  the  education  of  the 
American  business  man  in  the  science  of  currency  and 
banking,  at  least  to  the  extent  that  he  appreciates  as 
never  before  the  relation  between  a  defective  currency 
system  and  his  own  prosperity.  He  feels  that  much  of 
the  loss  and  suffering  of  that  disaster  was  unnecessary, 
and  that  in  the  future  repetitions  may  be  considerably 
mitigated. 

If  an  architect  should  plan  the  construction  of  a 
building  which  collapsed  in  the  first  severe  storm,  he 
would  probably  be  held  for  criminal  neglect  in  disre- 
garding the  laws  and  principles  of  scientific  construc- 
tion. Should  not  the  architects  of  our  currency  and 
banking  systems  be  held  equally  responsible  for  the  col- 
lapse of  their  structures  when  they  have  disregarded 
scientific  principles  clearly  established? 

The  study  of  the  science  of  currency  and  banking  is 
not  only  obligatory  upon  the  architects  of  our  monetary 
system,  but  it  is  also  profitable  to  those  who  must  adapt 
their  business  to  existing  systems.  If  the  system  is  de- 
fective, they  must  know  how  to  escape  the  consequences 
of  such  defects ;  they  must  know  enough  to  move  out  of 


FUNDAMENTAL  ECONOMIC  CONCEPTS  3 

the  building  when  the  first  cracks  appear  in  the  walls, 
or  when  evidences  of  a  storm  are  manifest. 

2.  Warnings  of  the  late  panic. — During  the  winter 
of  1906  and  the  summer  of  1907  the  economists  and 
students  of  finance  had  sent  out  bulletins  of  warning 
and  displayed  storm  signals  of  the  approaching  trouble. 
The  intelligent  navigator  of  business  craft  who  could 
understand  the  significance  of  these  signals  sailed  close 
to  the  shore  or  kept  in  port,  while  the  heedless  and  igno- 
rant put  up  full  sail  to  take  advantage  of  the  breeze  of 
prosperity,  and  found  themselves  caught  unawares  in 
the  squall  of  October. 

3.  Science. — Science  is  the  study  of  the  relation  of 
cause  and  effect.     Man  has  an  inborn  curiosity  to  know 
the  reason  for  things,  in  order  that  he  may  be  master  of 
his  environment  and  that  he  may  know  how  to  produce 
desired  effects  through  his  power  over  the  causes  pro- 
ducing those  effects.     Therefore,  our  ultimate  aim  in 
studying  the  science  to  which  we  have  addressed  our- 
selves is  to  be  able  to  make  use  of  such  knowledge  in 
increasing  our  business  efficiency,  and  avoiding  waste 
of  effort  in  materials  through  ignorance. 

Money  and  Banking  is  a  part  of  the  science  of  finance, 
which  in  turn  is  one  of  the  branches  of  the  more  general 
subject  of  Economics  or  political  economy. 

4.  Finance. — Political   Economy   is   the   science   of 
business;  that  is  to  say,  the  science  of  the  relations  of 
men  with  each  other  in  the  production,  consumption, 
distribution  and  exchange  of  goods.     Finance,  one  of 
the  subdivisions  of  the  field  of  economics,  deals  with 
control  of  property,  especially  with  that  form  of  prop- 
erty which  economists  call  the  production  goods,  i.  e., 
land,  natural  resources,  factories,  railroads,  machinery, 
etc.     Control  of  property  is  attained 'through  changes 


4  MONEY  AND  BANKING 

of  ownership,  or  possession  of  the  highest  efficiency 
in  production  goods.  Finance,  therefore,  is  a  science 
which  treats  of  the  assembling  and  management  of  cap- 
ital, using  the  term  in  the  broadest  sense.  It  also  treats 
of  the  methods  and  instruments  used  necessary  to  this 
end,  hence  including  money  and  banking.  Money  and 
banking  deals  with  the  instruments  and  methods,  through 
the  agency  of  which  the  exchange  of  property  of  all 
kinds  is  accomplished.  The  ultimate  object  of  all  busi- 
ness is  to  produce  the  largest  amount  of  wealth,  and  to 
distribute  this  product  to  the  consumers.  Wealth  is 
the  general  term  which  includes  all  material  things 
which  satisfy  human  wants.  In  other  words  it  includes 
those  things  which  possess  the  quality  called  utility, 
which  is  simply  the  power  to  satisfy  human  wants  di- 
rectly or  indirectly.  In  order  to  create  this  quality  of 
utility  in  material  things  it  is  necessary  to  bring  together 
three  things ;  labor,  natural  resources,  and  capital  goods. 
This  latter  term  includes  all  the  artificial  instruments  of 
production — tools,  buildings,  railroads — which  have 
been  made  by  men. 

5.  Technology  and  business. — In  every  enterprise 
there  are  two  distinct  sides,  that  is,  a  technical  and  a 
business  side.  The  manufacturer  must  not  only  have 
knowledge  of  the  best  methods  and  processes  for  turn- 
ing out  his  product,  but  he  must  know  how  to  buy  his 
materials,  hire  his  labor,  secure  and  invest  his  capital 
and  sell  his  product. 

Economics  has  nothing  to  do  with  the  technical  side 
of  industiy.  It  is  not  concerned  with  the  best  methods 
of  treating  the  soil  in  agriculture  nor  with  the  construc- 
tion of  machines  in  manufacturing.  It  confines  itself 
solely  to  the  study  of  the  organization  and  relations  of 
the  three  factors  of  production,  land,  natural  resources, 


FUNDAMENTAL  ECONOMIC  CONCEPTS  5 

and  capital  goods.  If  everybody  provided  for  his  own 
wants  first,  by  producing  what  he  consumed,  there 
would  be  no  such  thing  as  business  and  economics. 
Business  begins  the  moment  one  person  produces  some- 
thing for  another  but  depends  upon  another  to  supply 
him  by  exchange  with  the  things  he  needs.  Since  prac- 
tically nobody  is  economically  self-sufficient  in  these 
days,  everybody  is  concerned  with  business  problems. 

6.  Business  the  result  of  specialization  of  labor. — 
This  fact  of  the  universal  division  of  labor  or  specializa- 
tion of  labor  is  the  very  foundation  of  our  economic  sys- 
tem.    The  procedure  of  a  modern  man  in  supplying  his 
wants  is  very  indirect.     If  he  hasn't  some  already,  his 
first  move  is  to  supply  himself  with  money  which  he  ex- 
changes for  the  goods  with  the  merchant.     The  mer- 
chant has  previously  acquired  the  goods  in  a  roundabout 
way  through  the  channels  of  trade  from  the  producers. 
The  producers  are  organizations  of  men  who  take  the 
materials  from  their  natural  state  and  work  them  up 
into  finished  goods  capable  of  satisfying  human  wants. 
The  work  of  the  world,  in  which  we  observe  nearly 
everybody  so  busily  engaged,  is  production.     Sometimes 
it  requires  very  close  analysis  to  discover  how  some 
occupations  assist  in  preparing  goods  for  consumption 
and  use.     At  first  sight  such  occupations  as  banking, 
brokerage,  accounting,  etc.,  seem  to  have  little  to  do 
with  the  production  of  goods,  and  yet  as  we  shall  see 
further  on,  they  are  as  necessary  and  effective  to  this 
end  as  agriculture  and  manufacturing. 

7.  Production. — To    create   the    greatest   utility    in 
goods — that  is,  to  give  them  the  maximum  power  to  sat- 
isfy human  wants,  they  must  be  given  the  proper  form; 
they  must  be  ready  for  consumption  at  the  proper  time 
and  in  the  proper  place;  and  lastly  they  must  be  in 


6  MONEY  AND  BANKING 

the  possession  of  the  consumer,  to  whom  they  afford  the 
highest  gratification,  or  at  least  in  the  possession  of  the 
person  who  is  willing  to  sacrifice  the  most  for  them. 

Thus  production  consists  not  only  in  changing  the 
form  of  material  things,  such  as  changing  the  chem- 
ical elements  of  the  soil  into  wheat  and  finally  into 
bread,  or  transforming  the  standing  timber  into  a  dwell- 
ing house.  It  consists  just  as  truly  in  changing  the 
locality  of  the  goods ;  for  instance,  wheat  in  Dakota  has 
very  small  utility  to  the  people,  but  after  it  has  been 
transported  to  New  York  City  it  gains  immensely  in 
utility.  Still  further  the  mere  holding  of  goods  from 
one  time  to  another  may  increase  their  utility.  It  is  the 
function  of  merchants  and  warehousemen  to  hold  goods 
until  they  shall  be  called  for  by  the  consumers.  These 
persons  create  utility  just  as  truly,  though  not  as  ob- 
viously, as  the  farmer  or  the  manufacturer. 

8.  Production  by  change  of  ownership. — Lastly  util- 
ity of  goods  is  increased  by  changing  the  ownership  of 
them.  It  is  with  this  last  phase  of  production  with 
which  we  are  concerned  in  the  study  of  money  and  bank- 
ing. Under  our  system  of  specialized  industry,  prod- 
ucts have  very  little  utility  to  the  producer.  While  the 
products  of  other  producers  have  very  high  utility,  by 
exchanging  his  own  for  products  of  others,  each  gains 
in  the  amount  of  utility  at  his  disposal.  This  opera- 
tion of  exchange  is  relatively  simple  when  the  producers 
and  consumers  are  close  to  each  other,  but  when  the  pro- 
ducer is  a  Chinese  tea  grower  and  the  consumer  an 
elderly  English  lady  several  thousand  miles  away,  the 
process  of  getting  the  tea  from  one  to  the  other  is  a 
very  complicated  affair,  requiring  for  its  accomplish- 
ment a  vast  number  of  institutions  and  ingenious  de- 
vices. 


FUNDAMENTAL  ECONOMIC  CONCEPTS          3 


All  our  modern  material  civilization  is  practically  due 
to  the  extension  of  the  principle  of  the  division  of  labor. 
It  is  only  within  the  last  century  or  two  that  the  whole 
population  is  engaged  in  producing  things  which  they 
do  not  intend  to  consume.  The  enormous  increase  in 
efficiency  of  this  method  over  the  method  of  each  pro- 
ducing for  himself  is  instantly  apparent  when  we  reflect 
on  what  portion  of  the  wealth  which  we  consume  daily 
would  be  ours  if  we  were  obliged  to  produce  it  by  our 
own  unaided  efforts.  Now  this  whole  system  of  divi- 
sion of  labor  depends  upon  the  exchange  of  goods. 
The  products  must  find  the  consumers,  and  this  involves 
from  one  to  one  hundred  changes  of  ownership.  There- 
fore we  see  that  our  modern  civilization  has  been  de- 
pendent upon  the  growth  of  commerce,  and  future 
developments  in  the  division  of  labor  will  depend  upon 
the  facility  with  which  its  various  classes  of  commodities 
can  be  exchanged. 

9.  Tardy  recognition  of  value  of  exchange. — It  is  a 
curious  fact  that  this  most  vital  part  of  civilization  and 
commerce,  money  and  banking,  has  not  been  understood 
and  appreciated  until  recent  times.  A  few  centuries 
ago,  the  merchant  was  regarded  with  suspicion  and 
placed  not  far  above  the  thief  in  the  social  scale.  The 
merchant  who  bought  an  article  for  $1  and  sold  it  for 
$1.50  was  thought  to  have  robbed  the  purchaser  of  50 
cents.  The  banker  who  loaned  money  at  interest  vio- 
lated one  of  the  laws  of  the  church  which  forbade  taking 
of  usury,  as  interest  was  called  at  that  time.  It  is 
only  in  very  recent  times  that  the  persons  who  perform 
this  most  vital  economic  function  of  exchange — the 
bankers,  financiers,  brokers  and  merchants — have  been 
understood  and  appreciated,  and  even  yet  we  find  the 
medieval  idea  still  prevalent  among  a  large  class  of  peo- 


8  MONEY  AND  BANKING 

pie  that  these  persons  are  non-producers  and  parasites.1 
Such  persons  fail  to  see  that  without  the  activity  of  these 
non-producers,  the  labor  of  the  working  man  in  field 
and  shop  would  probably  be  less  than  one-tenth  as  ef- 
fective in  producing  real  wealth  as  it  now  is. 

10.  Private  property. — The  most  fundamental  insti- 
tution of  our  economic  system  is  that  of  private  prop- 
erty.    If  we  take  a  sweeping  survey  of  the  world  we 
shall  perceive  that  those  countries  which  have  advanced 
farthest  in  civilization   and  economic  well-being   are 
those  in  which  the  rights  of  private  property  and  in- 
violability of  contracts  are  most  strictly  enforced.     The 
world  knows  no  other  way  to  secure  the  preservation 
and  utilization  of  its  resources,  or  the  production  of 
increasing  quantities  of  industrial  equipment  or  the  full 
efficiency  of  human  effort,  whether  of  hand  or  brain, 
than  by  the  protection  of  property  rights. 

11.  Property  and  wealth. — Wealth  and  property  are 
not    synonymous    terms.    Wealth    signifies    material 
things  possessing  utility;  property  is  a  claim  which  con- 
fers control  over  the  use  of  wealth.    When  we  say  a 
person  is  wealthy,  we  mean  that  he  has  property  rights 
over  a  considerable  amount  of  utility-bearing  things. 
These  property  rights  are  of  great  variety,  from  abso- 
lute ownership,  subject  only  to  the  police  power  and  em- 
inent domain  of  the  government,  to  temporary  posses- 
sion of  the  tenant  or  borrower. 

A  great  many  things  popularly  classified  as  wealth 
are  not  real  wealth  at  all,  but  representatives  of  wealth, 
A  deed  is  not  wealth;  it  is  simply  an  evidence  of  prop- 
erty rights,  as  a  bond  is  simply  evidence  of  a  claim  for 
money  payment,  usually  secured  by  a  mortgage.  A 

i  Even  so  profound  a  philosopher  as  Lester  Ward  in  his  Dynamic  So- 
ciology written  in  1875,  fails  to  appreciate  the  economic  service  of  the  mer- 
chant and  financier. 


FUNDAMENTAL  ECONOMIC  CONCEPTS  9 

share  of  corporation  stock  is  a  claim  to  a  certain  portion 
of  the  earnings  of  a  corporation  set  aside  by  the  direc- 
tors as  available  for  dividends,  and  in  case  of  the  dis- 
solution of  the  corporation,  to  a  portion  of  the  assets. 
A  United  States  note  or  greenback  is  simply  an  evi- 
dence of  a  claim  against  the  Government  for  payment 
of  a  certain  number  of  dollars  on  demand.  The  fact 
that  it  is  readily  accepted  by  everybody  in  exchange  for 
wealth  does  not  make  it  real  wealth. 

A  gold  coin  is  real  wealth  to  the  extent  to  which  the 
metal  it  contains  has  utility.  In  the  case  of  all  the 
other  forms  of  money  we  are  confronted  with  a  prob- 
lem whether  to  classify  them  as  real  or  representative 
wealth.  Money  undoubtedly  has  an  indirect  utility  in 
so  far  as  it  assists  in  production,  and  would  seem  to  go 
along  in  the  same  category  as  railroad  cars,  which  in- 
crease the  utility  of  goods  by  moving  them  from  place 
to  place — money  increases  the  utility  of  goods  by  mov- 
ing them  from  owner  to  owner. 

We  have  seen  how  the  division  of  labor,  where  nearly 
everything  is  the  subject  of  private  property,  requires 
continual  exchanging  of  wealth  in  order  that  it  may 
come  under  control  of  the  persons  who  can  best  utilize 
it.  There  is  another  consequence  of  the  division  of 
labor:  It  requires  that  the  factors  of  production  be 
organized  in  great  groups,  in  order  to  be  most  effec- 
tively utilized. 

As  the  result  of  this  tendency,  we  have  the  United 
States  Steel  Corporation,  with  its  150,000  men  working 
with  a  billion  dollars'  wortK  of  natural  resources  and 
capital  goods,  and  with  the  production  of  iron  and 
steel.  This  grouping  together  of  a  large  number  of 
industries,  originally  independent  and  separate,  has 
eliminated  a  vast  number  of  exchanges.  From  the  iron 


10  MONEY  AND  BANKING 

ore  at  the  mine  to  the  finished  steel  rail  there  is  no 
change  of  ownership  of  the  materials. 

12.  Integration  of  industry. — As  a  consequence  of 
this  integration  of  industries  there  is  much  greater  sim- 
plicity and  much  less  risk  of  industrial  maladjustment 
than  before.  The  economy  of  this  integrated  tendency 
will  be  more  apparent  when  we  have  learned  how  indus- 
trial crises,  speculation  or  trade  depressions  are  caused 
by  failure  of  the  mechanism  of  exchange  to  work  prop- 
erly. As  we  decrease  the  number  of  exchanges  in  the 
normal  production,  we  reduce  by  so  much  the  oppor- 
tunities for  breakdowns. 

These  fundamental  economic  facts  and  principles  are 
mentioned  here  to  give  the  student  a  proper  idea  of  the 
relation  which  money  and  banking  bear  to  our  whole 
industrial  system.  Money  is  an  instrument  and  bank- 
ing an  institution  to  assist  production  of  wealth  and 
thereby  increase  the  material  welfare  of  the  people  by 
facilitating  the  indispensable  operations  of  exchange, 
without  which  all  other  productive  effort  would  have 
but  a  fraction  of  its  efficacy,  without  which  we  would 
still  be  in  the  state  of  industrial  barbarism. 

The  idea  of  private  property  is  not  as  a  great  many 
would  imagine,  innate  in  the  human  mind;  it  is  a  prod- 
uct of  centuries  of  slow  evolution  developed  by  neces- 
sity. Among  the  most  primitive  peoples  communism  is 
general,  except  in  things  peculiarly  personal.  The  first 
exchanging  was  not  between  individuals,  but  between 
tribes,  and  originated  in  mutual  gifts  rather  than  any 
contract  of  quid  pro  quo. 


CHAPTER  II 

EXCHANGE 

13.  Beginning  of  exchange. — Regular  exchange  did 
not  exist  until  one  tribe  had  a  surplus  of  particular  com- 
modities which  were  desired  by  the  tribes  having  no 
facilities  for  producing  them.  These  articles,  which 
were  superfluous  in  the  tribe  producing  them,  had  a  pe- 
culiar value  to  other  tribes  which  perhaps  could  not 
produce  them  at  all.  If  these  commodities  happen  to 
be  of  an  imperishable  nature,  as  pottery,  weapons  or 
furs,  they  might  easily  come  to  have  a  use  as  a  medium 
of  exchange  for  home  products.  The  necessity  of  ob- 
taining such  commodities  from  other  tribes  gave  them 
a  kind  of  fixed  value,  and  thus  they  became  the  most 
convenient  standard  by  which  the  value  of  all  other 
things  could  be  compared. 

In  the  evolution  of  money  a  vast  number  of  things 
have  been  used  for  the  purpose  of  fixing  values,  but 
practically  all  of  them  represent  surplus  products  which 
could  be  exchanged  with  foreign  tribes  or  nations  for 
imported  wares. 

Exchanging  of  goods  within  the  tribes  was  a  very 
slow  development,  and  when  it  did  develop  it  was  most 
natural  for  these  articles  of  foreign  origin  with  a  fairly 
definite  exchange  value  already  fixed  to  become  the 
common  medium  of  exchange  and  standard  of  value. 

By  some  authorities  economic  history  has  been  di- 
vided into  three  stages,  according  to  the  method  by 
which  exchanges  were  made:  Barter,  money  and  credit. 

11 


12  MONEY  AND  BANKING 

In  the  first  or  "barter"  stage  goods  were  exchanged  for 
goods.  In  the  second  stage  certain  goods  had  acquired 
an  exchangeability  greater  than  others,  and  were  ac- 
cepted not  only  because  they  had  utility  for  human  uses, 
but  also  because  they  had  this  additional  utility  of  ex- 
changeability. People  accepted  them  not  because  they 
desired  them  to  use,  but  because  they  knew  they  could 
get  by  trading  things  they  really  did  want  for  use. 
Thus  these  special  commodities,  such  as  beaver  skins, 
beads,  tobacco,  etc.,  came  to  have  a  value  quite  apart 
from  their  commodity  utility.  We  shall  see  when  we 
come  to  the  study  of  "value"  that  one  of  the  principal 
factors  which  confers  value  on  goods  is  utility.  This 
extra  exchange  utility  is  the  most  important  element  in 
the  value  of  money. 

14.  Barter. — The  limitations  of  exchange  by  barter 
are  obvious.     The  two  objects  to  be  exchanged  must  be 
of  approximately  equal  value  or  the  difference  must  be 
made  up  by  adding  smaller  articles  until  an  equivalence 
of  value  is  reached ;  otherwise  no  exchange  can  be  made. 
If  one  man  has  a  skin  which  he  wishes  to  trade  for  food, 
he  must  find  somebody  with  a  surplus  of  food  who 
wants  a  skin.     If  the  skin  is  very  valuable  the  owner 
might  be  compelled  to  take  a  large  quantity  of  food  at 
one  time,  perhaps  much  more  than  he  wanted.     In  the 
barter  stage,  therefore,  exchange  was  so  clumsy  and  un- 
certain that  it  was  of  necessity  incidental  rather  than 
essential  in  economic  life.     It  was  hazardous  for  men 
to  set  about  manufacturing  articles  for  which  they  had 
no  use  themselves  and  expect  by  exchange  to  obtain  the 
necessities  of  life.     In  this  stage  the  market  for  prod- 
ucts was  very  uncertain  and  could  not  be  depended 
upon. 

15.  Money. — Money  is  a  commodity,  as  we  have  seen, 


EXCHANGE  13 

but  when  it  is  exchanged  for  other  commodities  we  do 
not  call  the  operation  barter,  although  it  is  an  exchange 
of  goods  for  goods.  The  fact  that  one  of  the  ex- 
changed articles  is  accepted  solely  because  it  can  so 
easily  be  exchanged  for  something  else  which  the  holder 
really  wants  for  use  or  consumption,  introduces  an  en- 
tirely new  principle. 

Trading,  which  was  so  limited,  clumsy  and  uncertain 
in  the  stage  of  barter,  now  becomes  easy  and  regular. 
If  I  have  something  of  value  I  do  not  have  to  look 
about  to  search  out  the  person  who  not  only  wishes  to 
possess  it  but  who  has  something  which  I  need.  I  have 
simply  to  find  a  person  who  has  money,  because  I  know 
that  by  accepting  money  I  can  get  whatever  I  wish  with 
it.  Exchanges,  therefore,  become  three-sided.  First, 
the  trading  of  goods  for  money,  and  then  of  money  for 
goods.  The  first  part  of  the  operation,  the  exchanging 
of  goods  for  money,  is  but  the  first  half  of  the  complete 
exchange.  Until  the  money  has  been  spent  there  is  a 
suspended  exchange,  which  must  be  completed  sooner 
or  later  by  the  exchange  of  the  money  for  goods. 
Therefore,  all  trade  is  finally  barter,  and  the  use  of 
one  commodity  in  this  peculiar  way  as  money  compli- 
cates, but  also  greatly  facilitates,  exchanging  of  goods 
for  goods. 

16.  Money  represents  incomplete  exchanges. — All 
money  existing  at  this  moment  represents  incomplete 
exchanges.  Every  possessor  of  it  will  sooner  or  later 
offer  it  for  goods,  because  money  has  no  use  except  to 
be  spent.  There  is  no  utility  to  be  had  from  it  until 
it  is  parted  with.  The  miser  perhaps  realizes  a  certain 
satisfaction  from  the  mere  possession  of  money,  but 
with  the  rational  person  the  possession  of  money  repre- 
sents a  postponed  satisfaction.  Quite  naturally  the  an- 


14  MONEY  AND  BANKING 

ticipation  of  future  satisfaction  to  be  obtained  is  quite 
pleasurable,  but  to  say  that  the  money  rather  than  the 
anticipation  is  the  source  of  the  satisfaction  is  to  fall 
into  confusion  of  thought.  The  boy  with  the  circus 
ticket  in  his  hand  is  filled  with  joyous  sensations  when- 
ever he  gazes  upon  it.  A  railroad  ticket  to  California 
conjures  up  the  smell  of  orange  groves  and  other  de- 
lightful things.  But  neither  of  these  things  is  the  real 
source  of  the  gratification.  The  miser  is  the  boy  who 
prefers  to  miss  the  circus  rather  than  to  give  up  the 
ticket. 

17.  Credit. — There  is  still  a  third  stage  of  economic 
evolution  beyond  the  stages  of  barter  and  money.  This 
we  call  the  credit  stage.  Just  as  exchanges  were  limited 
and  clumsy  in  the  barter  stage,  necessitating  the  inven- 
tion of  money  before  men  could  specialize  in  production 
to  any  great  extent,  so  the  time  arrived,  in  the  Middle 
Ages  perhaps  (although  the  use  of  credit  was  not  un- 
known in  the  ancient  world) ,  when  money,  even  the  most 
refined  forms  and  systems  of  money,  became  too  cum- 
bersome. 

In  this  last  stage  exchanges  can  be  made  without  the 
use  of  money  at  all.  A  man  may  be  able  to  buy  and  sell 
without  possessing  any  money,  or  even  any  property. 
The  consideration  he  gives  may  be  merely  a  promise  to 
pay  money  or  its  equivalent  value  at  a  future  time.  In 
this  last  stage  exchange  frees  itself  entirely  from  former 
limitations  and  under  specialization  of  industry  can  ex- 
tend until  scarcely  any  man  produces  the  thing  he  him- 
self consumes.  Everything  is  produced  for  the  market, 
and  the  market  does  not  fail  so  long  as  the  machin- 
ery of  credit  is  working  smoothly.  Unfortunately, 
credit  is  like  fire,  and  its  use  is  attended  with  risk,  but 
nobody  would  think  of  foregoing  the  use  of  fire  be- 


EXCHANGE  15 

cause  Houses  sometimes  burn  down,  nor  would  anybody 
advocate  the  abolition  of  credit  because  sometimes  its 
abuse  brings  on  commercial  disasters  and  panics. 

Throughout  this  book  the  word  "credit"  will  be  used 
in  a  strictly  technical  sense,  that  is  to  say,  with  the  fol- 
lowing meaning:  Credit  is  a  postponed  payment  of 
money.  The  word  is  employed  in  ordinary  usage 
to  mean  the  ability  to  borrow.  Thus,  a  person  has 
good  credit  when  his  reputation  for  financial  integ- 
rity makes  it  easy  for  him  to  borrow  the  funds  or  prop- 
erty of  others.  Much  of  the  difficulty  and  confusion  in- 
herent in  the  discussions  of  credit  grow  out  of  this 
vague  usage  of  the  word.  If  it  is  kept  in  mind  that  a 
credit  is  a  perfectly  definite  tiling,  i.  e.,  a  postponed 
payment  of  money,  clear  thinking  will  be  possible. 

Our  definition  implies  an  incomplete  exchange.  One 
side  of  the  exchange  has  been  completed,  but  so  far  no 
equivalent  has  been  rendered.  The  payment  has  been 
postponed.  It  is  convenient,  however,  to  regard  the 
credit  as  itself  an  equivalent  and  a  thing  having  value. 
If  a  merchant  sells  a  bill  of  goods  to  a  customer  and 
agrees  to  postpone  the  payment  for  three  months,  he 
has  received  for  the  goods  a  promise,  which  is  valued  by 
him  as  the  full  equivalent  of  the  goods.  If  this  prom- 
ise is  put  in  the  form  of  a  promissory  note  (which  is 
simply  a  documentary  evidence  of  the  promise)  this 
promissory  note  is  a  concrete  object  of  value  and  can 
be  itself  exchanged  for  other  things  of  value. 

18.  Credits  as  media  of  exchange. — The  fact  that  a 
promise  to  pay  money  is  a  valuable  thing  in  itself  sug- 
gests immediately  the  possibility  of  using  such  promises 
as  a  medium  of  exchange  if  they  can  be  put  into  such 
form  that  the  ownership  in  them  or  the  title  to  them 
can  be  transferred  from  hand  to  hand.  Just  as  the 


16  MONEY  AND  BANKING 

value  of  money  is  an  artificial  quality,  created  by  its 
ready  exchangeability,  so  credit  may  come  to  have  a 
value  for  the  same  reason.  People  accept  money  read- 
ily in  exchange  for  anything  else  because  they  know 
that  it  gives  them  command  over  any  piece  of  property 
that  is  for  sale.  In  other  words,  because  it  is  converti- 
ble into  property  practically  at  all  times,  in  all  places 
and  under  all  circumstances.  Likewise,  credit  has  value 
as  a  medium  of  exchange  only  to  the  extent  to  which  it 
is  convertible  into  money  or  directly  into  property.  Con- 
vertibility is  therefore  the  very  essence  of  the  value 
of  money  and  credit. 

Money  we  saw  was  simply  an  indirect  barter,  the  op- 
eration being  lengthened  by  the  use  of  an  intermediate 
thing  called  money.  With  the  use  of  credit  the  opera- 
tion is  still  further  lengthened,  and  the  steps  in  the  com- 
plete transaction  may  run  as  follows :  Goods  are  traded 
for  credit;  credit  is  traded  for  money;  money  is  ex- 
changed for  goods. 

Suppose  a  merchant  buys  a  bill  of  dry-goods  from  a 
wholesale  establishment  and  gives  his  three-months  note 
therefor.  The  wholesale  house  may  take  this  note  to  the 
bank  for  discount,  receiving  a  credit  on  its  deposit  ac- 
count. When  the  note  is  due  the  bank  may  receive  a 
check  from  the  retail  merchant  who  made  it.  This 
check  may  be  cashed  at  another  bank  and  may  be  paid 
out  again  to  a  manufacturer,  who  has  received  a  check 
from  the  wholesaler  drawn  against  his  deposit  at  the 
bank.  The  manufacturer  may  use  this  cash  to  buy 
cotton  from  the  customer  of  the  merchant  who  consumes 
the  dry-goods  first  bought.  Reduced  to  its  simplest 
terms,  the  cotton  grower  has  bartered  his  cotton  for 
cloth,  but  the  transaction  has  involved  a  very  compli- 
cated series  of  exchanges  in  order  to  accomplish  it. 


EXCHANGE  17 

This  complexity  introduced  by  the  use  of  money  and 
credit  would  seem  to  increase  the  difficulty  of  exchang- 
ing goods  for  goods,  but  in  reality  it  facilitates  the  proc- 
ess immensely.  While  seemingly  the  most  expensive 
mode  of  making  exchanges,  in  reality  it  is  the  most  eco- 
nomical. The  profits  and  salaries  paid  to  the  merchants 
and  bankers  are  added  to  the  cost  of  the  finished  cloth, 
and  the  planter  must  give  so  much  more  raw  cotton  for 
it,  but  if  these  middle  men  did  not  exist  it  is  likely  that 
the  planter  would  have  to  manufacture  the  cotton  and 
the  cloth  himself  at  a  hundred  times  the  real  final  cost. 
This  is  a  case  where  the  most  indirect  route  is  in  reality 
the  shortest  and  cheapest. 

19.  Money  and  credit  representatives  of  wealth. — 
Money  and  credit  are  representatives  of  wealth  rather 
than  real  wealth.  This  statement  seems  to  involve  a 
paradox  because  of  the  habit  which  has  been  acquired 
of  regarding  as  wealthy  a  person  who  has  control  over 
a  large  sum  of  money  or  credit.  The  popular  concep- 
tion of  a  wealthy  man  is  very  likely  to  approximate  the 
cartoonist's  idea  of  a  rotund  individual  wearing  a  silk 
hat  and  a  costume  with  a  dollar-mark  pattern  and  sur- 
rounded by  bags  of  specie. 

The  wealthy  person  in  reality  is  one  who  has  control 
over  a  large  amount  of  goods  or  real  wealth.  How- 
ever, in  estimating  wealth  we  find  it  convenient  to  reduce 
it  to  a  sum  of  dollars'  worth  rather  than  to  enu- 
merate all  the  items  of  goods  contained  in  it.  A  mil- 
lionaire is  not  a  person  who  owns  a  million  dollars  in 
money,  but  whose  property  rights  are  estimated  in  terms 
of  dollars.  The  millionaire  may  rarely  have  in  his  per- 
sonal possession  more  than  a  thousand  dollars  in  money, 
but  because  his  property  rights  are  more  or  less  con- 
vertible into  money  we  fall  into  the  error  of  carelessly 

VII— 9 


18  MONEY  AND  BANKING 

considering  him  as  possessed  of  a  million  dollars.  Un- 
less we  think  clearly  on  this  point  and  rid  ourselves  of 
this  error,  we  are  likely  to  find  ourselves  blocked  in 
dealing  with  problems  in  money  and  banking. 

The  value  of  money,  except  in  the  case  of  metal  coins, 
which  have  a  commodity  utility,  is  dependent  upon  its 
convertibility  from  property  into  goods.  If  everybody 
attempted  to  convert  the  money  and  credit  in  the  world 
into  goods  simultaneously,  money  and  credit  would  lose 
its  value  entirely.  It  is  only  because  there  is  a  real  need 
for  this  particular  kind  of  utility  in  making  exchanges 
that  the  value  of  money  and  credit  is  maintained.  The 
value  of  money  and  credit,  then,  is  dependent  entirely 
upon  a  habit  which  people  have  of  accepting  them  in 
exchange.  When  there  is  any  reason  to  doubt  that 
money  and  credit  will  be  accepted,  we  find  its  value 
shrinking  away  and  are  confronted  with  the  phenom- 
enon of  a  depreciated  currency. 

20.  Classification  of  wealth. — There  are  two  kinds  of 
economic  goods:  "Consumption  goods,"  which  have 
direct  utility  and  satisfy  a  human  want,  and  "production 
goods,"  which  have  indirect  utility  and  assist  in  pro- 
ducing consumption  goods.  The  value  of  production 
goods  is  entirely  dependent  upon  the  consumption  goods 
which  they  help  to  produce,  just  as  the  value  of  labor  is 
derived  from  its  product.  If  production  goods  or  labor 
is  so  limited  that  it  can  produce  only  goods  which  have 
no  market  value,  they  are  themselves  valueless.  Work- 
men may  be  ever  so  skilled  in  certain  lines  of  work,  but 
if  the  product  is  unmarketable  they  will  look  in  vain  for 
employment.  The  machine  may  have  cost  $10,000,  but 
nevertheless  may  be  thrown  upon  the  scrap  heap  to-mor- 
row if  the  product  ceases  to  be  purchased  by  consumers, 


EXCHANGE  19 

or  if  another  machine  is  invented  for  doing  the  work 
more  cheaply. 

21.  Entrepreneur  system. — Production  requires  the 
employment  together  of  land,  labor  and  capital  goods. 
Under  the  cooperative  system  the  owners  of  the  capital 
goods  and  of  the  land  unite  with  the  laborers  in  the 
production  of  a  certain  commodity  and  divide  among 
themselves  the  product  or  the  proceeds  of  its  sale  on 
the  market.  This  system  of  industry  has  been  found 
less  satisfactory  as  a  rule  than  the  entrepreneur  system, 
so  called,  by  which  one  man,  the  entrepreneur,  under- 
takes the  responsibility  for  the  industry.  He  contracts 
at  a  fixed  rate  of  compensation  for  the  use  of  capital 
and  land,  and  hires  his  labor  at  fixed  wages.  He  en- 
deavors to  realize  from  the  enterprise  a  larger  net  sum 
than  the  payments  he  must  make  to  the  workingmen, 
the  capitalists  and  the  landlords.  The  difference  he 
keeps  for  himself  as  his  profit.  If  there  is  a  deficit 
he  suffers  the  loss.  As  a  rule  the  entrepreneur,  before  he 
can  make  contracts,  must  have  a  certain  amount  of  cap- 
ital of  his  own  as  a  margin  against  loss.  Otherwise,  the 
capitalists,  workingmen  and  landlords  must  have  an  ex- 
tra remuneration  for  the  risk  they  take.  In  dealing 
with  a  capitalist  the  entrepreneur  does  not  borrow  ma- 
chines or  other  forms  of  capital  goods,  but  he  borrows 
a  certain  sum  of  money  or  purchasing  power  which  he 
can  convert  at  will  into  production  goods.  The  cap- 
italist has  funds  or  purchasing  power  to  loan  to  the 
entrepreneur.  This  purchasing  power  represents  a 
claim  on  goods  in  general  which  are  for  sale  on  the 
market.  When  the  entrepreneur  borrows  these  funds 
he  immediately  uses  them  to  claim  whatever  he  needs 
in  his  business.  It  was  not  the  money  he  wanted,  but 


20  MONEY  AND  BANKING 

the  buildings,  the  machinery,  raw  materials,  etc.  Money 
is  not  necessary  in  production ;  it  is  simply  the  most  con- 
venient way  of  getting  control  of  the  things  needed. 

22.  Capital. — The  conception  of  capital  is  one  of 
the  most  difficult  and  confusing  in  the  whole  science  of 
economics.  Just  as  in  the  case  of  wealth,  most  people's 
idea  of  capital  is  a  sum  of  money.  Until  recently  most 
economic  writers  used  the  word  "capital"  to  include  not 
only  money,  but  everything  we  have  called  production 
goods.  The  fundamental  idea  in  the  word  "capital,"  if 
it  be  analyzed  closely,  seems  to  be  this:  a  source  of  in- 
come. The  Eskimo  would  call  his  canoe  a  part  of 
his  capital  because  he  could  attribute  to  its  use  in  fishing 
a  certain  proportion  of  the  day's  catch.  This  propor- 
tion might  be  measured  by  the  amount  of  fish  he  could 
have  obtained  without  the  use  of  the  canoe.  If  he  could 
catch  five  fish  without  the  canoe  and  ten  fish  with  it, 
the  canoe  might  be  regarded  as  the  source  of  the  income 
of  five  fish.  Capital,  therefore,  has  economic  impor- 
tance only  as  a  source  of  income,  and  its  value  is  en- 
tirely proportionate  to  that  income. 

When  men  reached  the  stage  of  calculating  income 
in  dollars'  worth  instead  of  in  specific  commodities,  then 
capital,  the  source  of  the  income  in  dollars'  worth,  be- 
gan to  be  regarded  as  a  sum  of  value  rather  than  as  a 
machine  or  building,  etc.  Therefore,  we  might  say  that 
capital  is  an  abstract  concept  of  the  value  or  dollars' 
worth  appertaining  to  the  source  of  an  income,  whether 
such  source  is  tangible  or  intangible. 

The  merchant  regards  as  his  capital  his  stock  of  goods, 
his  store  building,  and  fixtures,  because  they  are  the 
source  of  his  money  income.  If  he  were  asked  to  make 
a  statement  as  to  his  capital,  he  would  sum  up  the 
values  of  his  business  in  terms  of  dollars. 


EXCHANGE  21 

23.  Capitalization. — The  word  "capitalization"  pre- 
sents a  difficult  conception  unless  we  hold  in  mind  the 
root  meaning  of  the  word  "capital":  Capitalization 
represents  the  relation  between  income  and  capital, 
which  may  be  made  clear  by  an  illustration.  Suppose 
a  manufacturer  has  a  plant  which  yields  him  a  net  in- 
come beside  his  own  salary  and  a  reasonable  profit  for 
undertaking  the  business  of  say  $10,000.  Suppose  this 
$10,000  is  the  average  for  a  number  of  years,  which  can 
be  made  a  safe  basis  for  future  calculation.  If  this 
manufacturer  were  asked  to  fix  a  price  on  his  establish- 
ment, how  would  he  go  about  it?  Perhaps  the  whole 
plant,  machinery,  building,  etc.,  did  not  cost  more  than 
$10,000  originally,  but  that  its  high  earning  power  is 
due  to  the  possession  of  a  patent  on  certain  of  the  ma- 
chinery. Obviously  he  would  not  be  willing  to  sell  the 
business  for  $10,000,  or  even  $20,000.  What  he  is 
really  selling  is  the  right  to  an  income  of  $10,000  per 
year.  The  price  which  he  would  demand  for  his  busi- 
ness would  not  be  much  less  than  he  would  have  to  pay 
to  obtain  the  $10,000  income  from  another  source.  If 
the  only  income  he  could  buy  with  the  proceeds  of  the 
sale  of  his  business  were  bonds  yielding  5  per  cent  per 
annum,  he  must  needs  receive  at  least  $200,000  in  order 
not  to  be  a  loser  in  the  transaction.  He  could  not  de- 
mand more  than  $200,000  because  no  purchaser  would 
be  willing  to  buy  a  $10,000  income  at  a  price  which 
would  purchase  a  $11,000  or  $12,000  income  in  the  se- 
curity market. 

If  the  owner  of  the  plant  thought  of  incorporating  a 
company  and  issuing  shares  of  stock,  he  would  be  con- 
fronted by  the  same  problem  of  placing  a  valuation  on 
the  business  in  order  to  properly  capitalize  the  corpora- 
tion. In  this  case  if  the  income  were  practically  fixed 


at  $10,000  and  there  was  a  wide  market  for  the  shares, 
it  is  likely  that  at  a  capitalization  of  $200,000  the  shares 
would  sell  at  somewhere  near  par.  That  is  to  say,  the 
total  sum  of  their  market  value  would  be  about  $200,- 
000. 

Capitalization,  therefore,  is  the  process  of  placing  a 
valuation  upon  the  source  of  an  income.  If  a  corpora- 
tion is  overcapitalized,  the  valuation  which  has  been 
placed  upon  its  assets  or  the  source  of  its  earning  power 
has  been  too  high ;  in  such  cases  the  shares  sell  below  par. 
This  may  happen  not  only  because  the  net  earnings 
are  too  small  as  compared  with  the  capitalization,  but 
because  of  the  uncertain  future,  or  because  the  de- 
mand for  them  is  very  limited.  Corporations  which 
have  been  overcapitalized  at  the  beginning  may  find 
that  the  overcapitalization  has  disappeared  in  the  course 
of  time  because  the  earnings  have  increased  in  amount 
and  stability.  In  the  language  of  finance,  "the  water 
has  been  squeezed  out  of  the  stock." 

This  subject  of  capital  and  capitalization  belongs  to 
the  broader  science  of  finance,  but  so  intimate  is  the 
relation  between  capital  and  currency  that  it  is  best  to 
get  a  clear  idea  of  capital  at  the  outset.  Capital  in  its 
various  forms  like  consumption  goods  must  change 
hands  in  order  to  realize  the  greatest  economies  in  pro- 
duction and  the  most  efficient  use  of  all  forms  of  pro- 
duction goods.  To  be  most  effectively  utilized,  the 
land,  machinery,  buildings,  materials,  etc.,  must  find 
their  way  into  control  of  those  entrepreneurs  who 
can  most  efficiently  organize  and  manage  them.  This 
very  intricate  process  gives  to  finance  its  mysterious 
and  difficult  character,  so  that  many  students  are 
frightened  away  at  the  outset.  The  movement  of  cap- 
ital is  so  intimately  related  to  money  and  banking  that 


EXCHANGE  23 

one  cannot  be  understood  without  mastering  the  other. 

24.  Demand  for  capital  goods. — Capital  goods  are 
produced  by  industry  for  the  market,  just  as  are  con- 
sumption goods.     They  are  produced  either  to  fill  a 
demand  already  existing,  as  when  the  manufacturers 
work  on  contracts,  or  they  are  made  in  anticipation  of 
a  market  when  they  are  ready  for  sale.    The  demand  for 
capital  goods  comes  from  entrepreneurs  who  wish  to  use 
them  in  industry  for  the  production  of  more  goods. 
Before  the  entrepreneur  can  take  capital  goods  off  the 
market  or  give  orders  for  their  manufacture,  he  must 
have  purchasing   power.     This  purchasing  power  he 
may  acquire  in  a  variety  of  ways.     First,  he  may  pos- 
sess the  purchasing  power  or  capital  as  his  own  prop- 
erty; second,  he  may  be  entrusted  with  the  purchasing 
power  or  capital  of  other  men  on  various  terms,  either 
for  a  fixed  compensation  per  annum  or  for  a  definite 
share  in  the  profits  of  the  business. 

This  purchasing  power  exists  in  the  form  of  money 
or  credit ;  in  most  cases  it  is  bank  credit  in  the  form  of  a 
deposit,  against  which  checks  can  be  drawn  to  make 
payments.  It  has  its  origin  in  income  which  has  not 
been  spent  for  consumption  goods  but  which  has  been 
saved.  Incomes  are  derived  originally  solely  from  pro- 
duction. Those  who  gain  a  personal  income  without 
producing  or  assisting  in  the  productive  process  appro- 
priate the  incomes  of  others ;  but  originally  every  income 
was  the  product  of  someone's  productive  industry. 

25.  Money  incomes. — Under  modern  conditions  very 
few  of  the  producers  take  a  share  of  the  product  as 
their  income.     They  prefer  to  convert  the  product  into 
purchasing  power,  that  is,  money  or  credit,  and  dis- 
tribute the  proceeds  as  money  income.     This  money  in- 
come, however,  is  simply  representative  of  the  products, 


24  MONEY  AND  BANKING 

and  is  convertible  into  any  goods  for  sale  on  the  mar- 
ket. Therefore,  if  these  income-receivers  prefer  to 
save  this  purchasing  power  rather  than  assert  their 
claim  to  a  certain  amount  of  consumption  goods,  they 
enlarge  the  fund  of  capital. 

iThe  motive  for  this  abstinence  from  consumption  is 
normally  not  for  the  purpose  of  abstaining  from  spend- 
ing indefinitely,  but  for  the  purpose  of  spending  di- 
rectly or  indirectly  for  production  goods  in  the  hope 
of  receiving  an  income.  This  conversion  of  purchasing 
power  into  production  goods  rather  than  consumption 
goods  is  real  investment.  If  it  were  not  for  this  saving 
and  investment  there  would  be  no  demand  for  capital 
goods  and  none  would  be  produced.  Saved  income, 
therefore,  represents  a  claim  to  a  certain  quantity  of 
production  goods  which  have  been  made  and  are  await- 
ing a  market  somewhere  in  the  world.  The  prospec- 
tive investor  is  the  man  who  determines  how  much  and 
what  kind  of  production  goods  shall  be  taken  off  the 
market,  thus  leaving  a  vacuum  to  be  filled  by  subsequent 
production. 

26.  Methods  of  investment. — A  very  small  propor- 
tion of  the  savers  or  of  the  original  creators  of  capital 
are  capable  of  investing  it  themselves.  The  merchant 
may  use  a  part  of  his  income  to  increase  his  stock,  or  the 
farmer  to  buy  new  implements,  fences,  etc.,  but 
probably  the  greater  part  of  all  saved  capital  is  turned 
over  to  other  entrepreneurs  for  investment.  There  are 
a  number  of  methods  by  which  the  capital  is  transferred 
from  the  saver  to  the  control  of  the  entrepreneur  who 
gives  the  orders  for  production  goods.  First,  the  saver 
may  deposit  his  savings  in  a  savings  bank,  thus  making 
the  bank  his  agent  for  the  investment  of  the  sum.  The 
savings  bank  will  perhaps  buy  bonds  of  a  railroad, 


EXCHANGE  25 

which  thus  obtains  the  capital  and  expends  it  in  rails 
and  equipment.  Secondly,  the  saver  may  deposit  his 
savings  in  a  commercial  bank,  in  which  case  the  capital 
finds  its  way  into  the  hands  of  commercial  borrowers  of 
the  bank  and  is  used  as  working  capital  to  buy  raw  ma- 
terials, to  pay  wages  and  to  carry  customers'  accounts 
for  short  periods.  Thirdly,  the  saver  may  himself  buy 
stocks  and  bonds  from  a  bond  house  or  a  trust  company, 
and  thus  make  these  institutions  his  agent  for  invest- 
ment. Fourthly,  the  saver  may  hoard  actual  cash, 
which  simply  means  that  investment  is  postponed  for 
the  time  being. 

27.  Real  investment. — In  the  ordinary  use  of  the 
term  the  purchase  of  stocks  and  bonds  in  the  market 
would  be  called  investment,  but  it  is  not,  however,  true 
investment.  In  this  case  the  saver  has  simply  shifted 
to  the  seller  of  the  bonds  the  responsibilty  for  the  real 
investment  of  the  capital,  i.  e.,  the  responsibility  for 
converting  it  into  production  goods.  It  is  only  when 
the  capital  is  in  the  hands  of  the  entrepreneur  that  an 
investment  can  take  place.  Entrepreneurs  are  con- 
stantly bidding  for  the  use  and  control  of  this  new 
capital  which  is  as  constantly  accumulating.  The  en- 
trepreneur who  can  offer  the  best  rate  of  interest  or 
the  highest  dividends  with  the  best  security  has  the  ad- 
vantage in  this  competitive  bidding. 

Under  our  modern  conditions  of  industry  the  large 
corporations  are  likely  to  be  able  to  use  this  capital  to 
the  best  advantage,  and  hence  are  in  a  position  to  make 
the  most  attractive  offers  to  savers.  Therefore,  we 
find  an  ever  increasing  percentage  of  the  savings  of  the 
community  flowing  in  that  direction.  This  is  to  the 
public  advantage,  in  so  far  as  the  corporation  is  able  to 
utilize  the  production  goods  to  which  the  capital  gives 


26  MONEY  AND  BANKING 

them  claim,  and  the  final  result  is  an  increased  amount 
of  product.  For  this  reason,  any  system  which  facili- 
tates the  flow  of  capital  from  the  savers  into  the  hands 
of  the  most  efficient  entrepreneurs  is  a  distinct  economic 
gain.  All  the  highly  specialized  financial  institutions 
perform  this  economic  service,  and  their  productivity, 
indirect  though  it  be,  is  to  be  measured  by  the  increased 
efficiency  of  the  capital  which  they  have  diverted  into 
the  most  productive  field.  The  stock  exchanges,  the 
financial  and  commercial  banks,  trust  companies,  under- 
writing syndicates  and  all  the  machinery  of  high  finance 
are  economically  beneficial  to  the  country  in  the  degree 
that  they  perform  this  function. 

Furthermore,  this  high  development  and  delicate  ad- 
justment of  financial  institutions  is  only  possible  when 
the  currency  of  the  country  is  of  the  soundest  and  most 
scientific  character.  Every  defect  in  the  currency  sys- 
tem makes  it  more  difficult  or  hazardous  for  such  insti- 
tutions to  do  business  and  is  a  handicap,  the  effect  of 
which  can  be  measured  by  the  diminished  efficiency  of 
all  the  industries  of  the  country.  The  man  who  says 
that  currency  and  banking  questions  are  no  concern  of 
his  would  probably  be  surprised  to  learn  that  his  wages 
are  smaller  or  the  prices  of  the  goods  he  buys  are  higher 
on  account  of  some  weakness  or  defect  in  the  system 
which  the  currency  reformers  are  striving  to  mend,  yet 
such  is  the  case.  Causes  which  are  the  most  potent  in 
producing  effects  are  frequently  the  most  obscure  and 
unappreciated. 


CHAPTER  III 

VALUE 

28.  Value  a  register  of  economic  forces. — Since  in 
our  modern  civilization  every  man  satisfies  his  wants 
through  exchange  of  what  he  produces  or  helps  to  pro- 
duce, for  what  he  consumes,  every  man  is  perforce  a 
dealer  in  values.  Specific  commodities  are  reduced  to 
terms  of  abstract  value,  and  are  dealt  in  as  such.  The 
workman  sells  his  labor,  say,  at  $100  a  month,  and  re- 
ceives an  income  of  $100  worth  of  goods  and  services 
of  his  own  choosing  from  the  market.  His  economic 
welfare  is  entirely  a  matter  of  the  relation  between  the 
effort  required  to  earn  the  wage,  and  the  amount  of 
utilities  which  can  be  obtained  with  that  wage.  Either 
a  fall  in  the  rate  of  wages  or  an  increase  in  the  prices 
of  goods  has  the  same  effect  in  altering  the  relation  to 
the  disadvantage  of  the  wage  earner.  Economic 
changes  therefore  always  appear  as  changes  in  values. 
Value  is  simply  a  register  or  index  of  economic  forces. 

The  reward  of  the  entrepreneur  for  his  productive 
efforts  comes  in  the  shape  of  profits.  Profit  is  simply 
the  difference  between  the  cost  of  the  product  and  the 
selling  price.  Any  change  of  values  which  alters  the 
cost  or  the  selling  prices  has  its  effect  on  profits,  either 
diminishing  or  increasing  them.  We  may  call  profits 
the  mainspring  of  industry,  because  they  are  the  mo- 
tive which  induces  the  entrepreneur  to  organize  industry 
by  borrowing  capital,  employing  labor  and  renting  land. 
When  the  expectation  of  profits  is  small,  the  entrepre- 

27 


28  MONEY  AND  BANKING 

neur  has  little  inducement  to  encourage  any  new  enter- 
prises or  to  extend  the  old.  From  such  circumstances 
dull  times  are  likely  to  ensue,  low  rates  of  interest  and 
smaller  wages,  or  nonemployment  of  workingmen. 
On  the  contrary,  when  the  expectation  of  profits  is  good 
there  is  likely  to  be  a  season  of  great  prosperity,  with 
every  resource  utilized  to  the  utmost,  and  labor  in  great 
demand  at  the  highest  wages.  Alternate  periods  of  de- 
pression and  prosperity  are  therefore  the  effects  of  cer- 
tain conditions  of  value. 

The  fact  that  currency  and  banking  have  a  most 
intimate  relation  to  values,  and  therefore  to  profits,  gives 
to  the  study  of  these  subjects  a  high  practical  utility. 
The  man  who  understands  the  effect  of  currency  and 
banking  conditions  on  values  is  in  a  position  to  fore- 
tell with  scientific  accuracy  the  future  course  of  prices, 
and  hence  may  prepare  himself  for  changes  in  general 
business  conditions. 

29.  Meaning  of  "value" — A  distinction  must  be 
made  between  the  terms  "value"  and  "price."  The 
value  of  an  article  is  its  exchange  relation  to  all  other 
articles.  The  value  of  this  book,  for  example,  can  be 
determined  only  by  comparison  with  something  else  hav- 
ing value,  as  for  instance  a  bushel  of  wheat.  The  value 
of  the  book  might  be  expressed  by  saying  that  it  is 
worth  five  bushels  of  wheat.  This  would  be  entirely 
satisfactory  to  anybody  who  had  a  definite  idea  of  the 
worth  of  five  bushels  of  wheat,  but  to  another  person  it 
might  mean  nothing  whatever.  In  order  to  make  com- 
parisons which  will  be  readily  understood  by  everybody, 
it  is  necessary  to  have  a  common  measure  or  denomina- 
tor of  value,  just  as  it  is  necessary  to  have  an  arbitrary 
unit  of  weight  or  length.  In  the  Bureau  of  Weights 
and  Standards  at  Washington  are  kept  certain  yard- 


VALUE  29 

sticks,  weights  and  vessels  which  are  the  standard  units 
of  length,  weight  and  capacity. 

30.  Definition  of  the  dollar. — Just  as  Congress  has 
declared  that  a  certain  length  shall  be  a  yard,  so  it  has 
also  declared  that  the  unit  of  value  shall  be  a  dollar,  of 
23.22  grains  of  pure  gold.     The  only  definition  for  a 
dollar  is  that  it  is  23.22  grains  of  gold.     All  other  dol- 
lars are  so  called  because  they  are  convertible  into  the 
standard  gold  dollar.     In  this  convertibility  lies  their 
value.     They  are  not  standard  dollars,  but  representa- 
tive dollars.     Price  is  simply  value  expressed  in  terms 
of  dollars.     If  I  say  this  book  is  worth  $5, 1  mean  that  it 
is  exchangeable  for  five  times  23.22  grains  of  gold,  or 
its  equivalent. 

If  we  speak  of  a  person  as  being  worth  $50,000, 
therefore,  we  mean  that  he  has  a  legal  title  to 
property  consisting  of  various  forms  of  wealth  having 
a  total  exchange  value  of  fifty  thousand  times  the  ex- 
change value  of  our  unit  of  gold,  or  its  equivalent.  In 
order  to  realize  this  exchangeability,  however,  it  is  first 
necessary  to  convert  the  wealth  into  money,  which  is 
ordinarily  very  difficult  to  do  at  the  market  price,  and 
then  convert  the  money  into  goods  desired,  which  is  very 
easy  to  do. 

31.  Exchangeability  the  sole  utility  of  money. — The 
desirability  of  money  as  a  form  of  property  is  due  solely 
to  its  ready  exchangeability;  for  any  other  purpose  it 
is    inferior,    producing   no    income,    as    do    factories, 
stocks,   bonds,   etc.,   and  requiring   extra   precautions 
against  theft.     Its  loanability  is  simply  another  form  of 
its  exchangeability.     The  borrower  purchases  the  in- 
come-yielding wealth  and  promises  to  divide  the  income 
with  the  lender. 

32.  Gold  not  an  ideal  standard. — Gold  is  very  far 


30  MONEY  AND  BANKING 

from  being  an  ideal  standard  of  value.  Suppose  the 
yard-stick  had  the  objectionable  habit  of  shrinking  and 
expanding,  being  thirty  inches  one  year  and  forty  inches 
the  next.  The  merchant  contracting  to  take  one  thou- 
sand yards  of  cloth  a  year  hence  would  run  the  risk  of 
losing  on  the  deal  merely  on  the  fluctuations  of  the 
yard-stick.  The  dollar  is  just  such  a  measure.  Its 
value  is  changing  constantly.  This  fact  is  concealed 
from  the  ordinary  observer,  who  attributes  all  fluctua- 
tions in  prices  to  commodities  rather  than  to  the  dollar 
itself. 

Value  is  a  ratio  between  23.22  grains  of  gold  in  a 
dollar  and  the  value  of  the  thing  to  be  measured.  The 
ratio  can  be  altered  by  the  changes  in  the  value  of  gold 
as  well  as  by  changes  in  the  value  of  goods.  If  wheat 
falls  to  50  cents  per  bushel  it  may  be  because  of  an 
alteration  in  the  relation  of  demand  to  supply  in  refer- 
ence to  wheat,  or  it  may  be  because  of  a  change  in  the 
value  of  money.  If  the  price  of  wheat  alone  has 
changed,  while  the  prices  of  all  other  commodities  re- 
main stable,  the  conclusion  must  be  that  the  changes 
were  due  to  causes  affecting  wheat  alone.  However, 
if  all  prices  have  shown  a  tendency  to  move  in  the  same 
direction,  especially  when  it  is  reasonably  certain  that 
there  have  been  no  changes  affecting  the  relation  of  sup- 
ply and  demand  of  these  goods,  the  explanation  of  the 
fall  in  prices  must  be  sought  in  money  itself. 

The  Free  Silver  Party  was  right  in  1896  when  it  at- 
tributed the  general  fall  of  prices  to  an  increase  in  the 
value  of  gold,  the  sole  standard  of  value.  Their 
remedy,  bimetallism,  or  a  double  standard  of  both  gold 
and  silver,  would  have  raised  prices,  but  it  would  have 
caused  such  a  disturbance  of  prices  and  credit,  both 


VALUE  31 

temporarily  and  permanently,  that  many  think  the  cure 
would  have  been  ten  times  worse  than  the  disease.  A 
discussion  of  this  principle,  however,  belongs  to  a  later 
chapter  on  the  Standard  of  Deferred  Payments. 

The  idea  that  the  value  of  the  dollar  is  a  constantly 
fluctuating  thing  is  so  novel  to  most  people  that  it  is 
worth  while  making  it  very  clear.  In  order  to  do  so  it 
is  perhaps  advisable  first  to  consider  the  general  prin- 
ciples which  govern  the  value  of  anything,  whether  it 
be  commodities  or  money. 

33.  Determination  of  value. — How  are  values  de- 
termined   and    what    forces    govern    the    fluctuations 
thereof?     The  statement  of  the  older  economists  is: 
Value  is  determined  by  Cost  of  Production.     A  thing  is 
worth  what  it  costs  to  produce.     The  insufficiency  of  this 
explanation  is  apparent  when  we  consider  the  great  num- 
ber of  things  whose  value  is  widely  different  from  or  has 
no  connection  with  its  cost  of  production;  land,  for  ex- 
ample, which  has  no  cost  of  production,  or  buildings  of 
unsuccessful  enterprises  which  may  sell  for  one-tenth  of 
their  cost. 

34.  Utility  theory  of  value. — A  modern  theory  holds 
that  value  is  determined  by  "utility."     Usefulness  or 
desirability  rather  than  cost  is  the  quality  which  gives 
a  thing  power  to  exchange  for  other  things.     Useful- 
ness, however,  is  a  matter  of  personal  estimate  and  va- 
ries infinitely  with  different  individuals.    Since  "value" 
is  expressed  by  the  market  price,  and  there  can  be  but 
one  market  price  for  the  same  thing  in  one  community 
under  the  same  circumstances,  the  utility  theorists  were 
forced  to  find  a  utility  which  was  usefulness  to  the  whole 
community  or  a  sort  of  average  utility.     This  they 
named  "marginal  utility,"  and  gave  the  world  an  ex- 


32  MONEY  AND  BANKING 

pression  which  has  been  found  extremely  useful.  The 
term  is  coming  into  common  use  and  is  therefore  worth 
understanding. 

35.  Marginal  utility. — In  a  small  city  there  might  be 
one  person  who  would  be  willing  and  able  to  give  any 
amount  up  to  $10,000  to  possess  a  machine;  there 
might  be  another  whose  limit  is  $9,500;  and  another  at 
$9,000  and  so  on.  As  we  go  down,  the  number  of 
possible  purchasers  increases  so  that  there  might  be 
several  hundred  at  a  price  between  $500  and  $1,000. 
This  potential  demand  for  automobiles  might  be  repre- 
sented by  the  following  diagram: 


8,000  — 
fi  nnn 

A 

B 

C 

4,000  — 
3  000 

D 

E 

F 

G 

1,000  — 
0  — 

H 

The  height  of  the  columns  represents  the  money 
equivalent  of  the  demand  for  automobiles,  and  the 
breadth  of  the  columns  represents  the  number  of  auto- 
mobiles which  would  be  bought  at  the  different  prices. 
Suppose  under  these  conditions  three  cars  were  brought 
to  that  city  for  sale.  The  man  A  would  pay  $10,000 
for  one  if  he  had  to,  but  he  knows  there  are  three  to  be 
sold,  so  he  refuses  to  pay  as  much  as  he  would  if  there 
were  only  one  for  sale.  To  dispose  of  the  three  auto- 
mobiles, the  dealer  must  not  demand  more  than  $9,000 ; 
at  that  price  A,  B,  and  C  will  supply  themselves  and 
thus  establish  the  market  price  in  that  city.  The  auto- 
mobiles may  not  have  cost  more  than  $1,000  to  produce, 
but  that  fact  would  have  no  weight  in  fixing  the  price. 
The  price  is  determined  by  the  "marginal  utility,"  that 
is,  by  the  utility  of  the  automobile  purchased  by  C,  who 


VALUE  33 

is  called  the  marginal  purchaser.  Margin  means  "edge" 
and  C  is  the  purchaser  who  is  on  the  edge  of  the  market. 
If  there  had  been  only  two  automobiles,  he  would  not 
have  been  supplied;  if  there  had  been  four  instead  of 
three  for  sale,  the  price  would  have  had  to  be  reduced 
to  $8,500  and  then  D  would  have  been  the  purchaser  on 
the  margin.  This  example  is  of  course  highly  the- 
oretical and  would  probably  never  happen  in  this  way 
in  real  life,  yet  the  principle  is  true  and  works  out  with 
greater  precision,  as  there  are  a  greater  number  of 
buyers  and  sellers,  and  as  the  knowledge  of  each  others' 
real  desires  increases. 

36.  Marginal  utility  to  the  individual. — In  the  illus- 
tration we  have  assumed  that  each  buyer  desires  but  one 
unit  of  the  article  for  sale.  With  many  classes 
of  goods,  each  buyer  may  desire  more  than  one  unit, 
cigars  for  instance.  Some  wealthy  men  might  give  a 
dollar  if  they  had  to  for  one  cigar  a  day  but  they  would 
not  give  so  much  for  a  second.  From  this  fact  we 
derive  the  "law  of  satiety,"  that  every  unit  of  a  com- 
modity consumed  yields  successively  less  satisfaction 
and  has  less  utility  to  the  consumer  than  its  predeces- 
sor. The  demand  of  any  one  consumer  for  units  of 
a  given  commodity  within  a  given  period  may  be  repre- 
sented by  the  following  diagram: 


SLOO- 
PS— 
.50  — 
.25  — 
.00  — 


1,    2,    3,    4,    5,    6th  cigar. 

To  make  a  chart  showing  the  demand  for  cigars,  it 
would  be  necessary  to  combine  the  charts  representing 
the  demand  of  each  consumer.  Suppose  for  the  sake 
of  simple  illustration  there  were  one  hundred  consumers 


VII— 3 


MONEY  AND  BANKING 


of  cigars  in  the  market,  each  with  a  potential  demand 
represented  by  the  foregoing  diagram,  a  chart  showing 
the  general  demand  would  be  thus : 


$1.00  — 
.75  — 



.25  — 
.00  — 

1st,       2nd,      3rd,      4th,      5th,       6th  one-hundred. 

Suppose  the  makers  of  this  particular  quality  of  cigar 
could  make  a  fair  profit  by  selling  them  at  25 
cents.  They  would  produce  five  hundred  because  they 
could  find  purchasers  for  that  quality  at  25  cents  each. 
They  could  not  get  more  because  there  can  be  but  one 
price  in  the  market,  and  the  buyers  assuming  that  they 
understand  the  situation,  will  pay  no  more  than  neces- 
sary. If  the  manufacturers  make  more  then  five  hun- 
dred cigars  and  attempt  to  sell  say  five  hundred  and 
fifty,  they  would  force  the  price  below  25  cents  and  de- 
stroy their  profit. 

37.  Reconciliation  of  the  two  theories. — It  is  easy  to 
understand  now  why  the  value  of  anything  that  can 
be  easily  produced  coincides  with  the  cost  of  production. 
If  the  value  is  much  above  the  cost  there  will  be  an  ab- 
normal profit  in  it,  producers  will  be  attracted  to  the 
business,  the  supply  will  be  increased,  and  the  price 
brought  down  by  the  competition  of  the  sellers  until 
it  coincides  with  the  cost.  Conversely,  if  the  value  is 
below  cost,  the  supply  will  be  reduced  on  account  of 
producers  leaving  the  business  and  the  price  will  rise  to 
the  cost.  If  the  supply  of  the  thing  is  fixed,  the  market 
price  and  cost  of  production  may  have  no  relation  to 
each  other. 


CHAPTER 

EVOLUTION  OF  THE  MEDIUM  OF  EXCHANGE 

38.  Primitive  ideas  of  value. — In  the  preceding 
chapter  we  have  described  how  the  necessity  for  the  ex- 
change of  goods  was  first  felt.  Long  before  the  rights 
of  private  property  were  recognized  within  the  tribe, 
there  was  exchanging  of  articles,  usually  luxuries,  or 
ornaments  or  goods  of  an  ornamental  character  between 
the  tribes ;  first  in  the  nature  of  gifts,  later  growing  into 
the  regular  systematic  exchange.  This  trade  was  direct 
barter,  no  medium  of  exchange  being  used. 

Later  when  private  property  rights  became  more 
definitely  recognized  within  the  tribe,  intra-tribal  ex- 
change sprang  up.  The  first  articles  of  this  traffic  were 
the  imported  goods,  to  which  a  more  definite  value  was 
ascribed,  influenced  by  the  limitations  in  the  supply. 
It  was  most  natural  that  these  articles  with  their  defi- 
nite value  should  become  the  measure  of  the  exchange 
value  for  the  goods  domestically  exchanged,  and  thus  we 
have  the  beginnings  of  the  idea  of  a  standard  of  value, 
still  very  crude  and  ill-defined  but  serving  the  pur- 
pose. 

Furthermore  these  imported  goods  were  as  a  rule 
highly  desired  by  everyone,  and  were,  therefore,  much 
easier  to  dispose  of  in  exchange  for  other  things  than 
domestic  commodities.  This  gave  to  them  an  additional 
utility  quite  aside  from  their  usefulness  or  their  ability 
to  satisfy  the  wants  of  their  possessors.  We  call  this 
utility,  "exchange  utility." 

35 


36  MONEY  AND  BANKING 

39.  Ornamental  stones  early  used  as  money. — Articles 
first  used  as  money  in  any  definite  way  of  which  we 
have    knowledge    were    ornamental    stones.     An    ex- 
travagant love  for  ornament  is  one  of  the  most  universal 
characteristics  of  savages.     They  are  likely  to  estimate 
ornaments  at  a  much  higher  value  than  the  more  neces- 
sary  commodities.     The   utility   of   these   ornamental 
stones  or  shells  was  so  constant  and  universal  that  the 
demand  for  them  was  likely  to  be  highly  stable.     The 
savage  was  quick  to  realize  that  if  he  could  possess 
himself  of  a  supply  of  these  articles  he  had  at  his  com- 
mand the  power  to  get  anything  else  of  which  he  might 
be  in  need.     Hence  these  stones  took  on  an  additional 
function  of  a  store  of  value,  easily  exchangeable  for 
other  values. 

40.  Three  functions  of  primitive  money. — Thus  in 
the  earliest  form  of  money  we  have  the  three  functions 
well  developed,  the  function  of  Exchangeability,  of  a 
Measure  of  Value,  and  of  a  Store  of  Value.     In  all  the 
more  primitive  nations  this  function  of  store  of  value 
was  more  important  than  in  modern  times.     Jewish 
women  of  the  Old  Testament  carried  about  their  per- 
son their  doweries  in  the  form  of  ornaments  and  jewels. 
The  East  Indians  of  to-day  convert  their  surplus  wealth 
into  silver  and  carry  it  about  with  them,  not  so  much 
from  an  extravagant  love  of  ornament  as  from  the  more 
practical  motive  of  having  always  at  hand  the  means  of 
obtaining  the  necessary  articles  of  livelihood.     As  we 
shall  see  later  this  custom  is  a  very  formidable  obstacle 
in  the  path  of  economic  development. 

41.  Wampum. — The  American  Indians  were  in  this 
stage  of  cultural  development  when  the  American  set- 
tlers first  came  in  contact  with  them.     They  had  elimi- 
nated all  forms  of  ornamental  money  except  wampum, 


EVOLUTION  OF  THE  MEDIUM  OF  EXCHANGE     37 

which  consisted  of  strings  of  beads  cut  from  shells. 
These  beads  were  of  two  colors,  white  and  black,  the 
black  being  worth  double  the  white.  In  trade  with  the 
Indians  the  settlers  found  it  convenient  to  use  wampum, 
and  it  therefore  acquired  a  very  definite  value  in  the 
colonies.  The  colonies  lacking  a  supply  of  gold  and 
silver  coins  were  compelled  to  make  payments  among 
themselves  in  wampum,  and  it  was  at  one  time  receiv- 
able as  legal  tender  for  payment  of  debts  to  the  amount 
of  ten  pounds  sterling,  or  about  $50.  The  disad- 
vantages of  this  form  of  money  were  manifest  when 
some  clever  but  more  unscrupulous  Europeans  invented 
a  method  of  dyeing  the  white  beads  black  and  doubling 
their  value  by  the  operation.  So  difficult  was  it  to  de- 
tect this  primitive  counterfeiting  that  wampum  soon 
came  into  discredit,  and  at  length  was  discarded. 

42.  Beaver  skins. — The  next  form  of  medium  of  ex- 
change to  be  adopted  for  trading  with  the  Indians  had 
the  merit  of  being  impossible  to  counterfeit.  The  steady 
demand  for  beaver  skins  for  manufacturing  into  hats 
in  England  gave  them  a  very  stable  value  among  the  col- 
onists, and  they  early  acquired  the  quality  of  exchange- 
ability in  addition  to  their  ordinary  utility.  When  a 
tribe  passed  from  the  hunting  to  the  pastoral  stage 
of  cultural  development,  it  was  natural  that  they  should 
adopt  a  commodity  for  money  which  existed  in  greater 
and  more  constant  supply  than  the  products  of  the  chase. 
Thus  we  find  among  the  ancient  Hebrews  and  Arabs 
that  cattle  were  used  for  the  purpose.  However,  it  is 
doubtful  whether  they  attained  any  great  circulation  as 
a  medium  of  exchange;  it  is  more  likely  that  they  per- 
formed the  function  of  a  measure  of  value.  In  the 
book  of  Genesis  we  constantly  read  statements  of  the 
wealth  of  individuals  as  measured  in  the  size  of  their 


38  MONEY  AND  BANKING 

flocks  and  herds.  The  great  disadvantage  of  the  use  of 
live  stock  as  money  arose  from  the  considerable  value 
in  each  indivisible  unit  and  its  perishability. 

43.  Agricultural  products  as  money. — In  the  next 
stage  of  cultural  progress,  namely  the  agricultural,  we 
find  the  products  of  the  earth  used  as  money.     Grain, 
tobacco  and  rice  formed  the  currencies  of  agricultural 
people.     The  disadvantage  encountered  in  this  variety 
of  money  was  the  uncertainty  of  the  supply.     In  years 
of  good  crops,  the  value  of  the  commodity  would  fall 
very  low  and  vice  versa  in  periods  of  scarcity.     This 
instability  of  value  was  a  great  disadvantage  in  these 
currencies.     Furthermore  the  fact  of  their  rapid  de- 
terioration when  stored  was  also  against  them.     One  of 
the  most  instructive  experiments  in  currency  was  that 
of  the  early  American  colonists  who  in  default  of  an 
inadequate  supply  of  metallic  money  to  which  they  were 
accustomed  in  England,  were  forced  to  make  use  of 
forms  of  currency  belonging  to  much  more  primitive 
peoples.     We  have  already  spoken  of  wampum  and 
beaver  skins.     The  early  settlers  in  Massachusetts  and 
Virginia  were  in  need  of  almost  every  kind  of  manufac- 
tured articles,  and  they  were  forced  to  import  such 
merchandise  from  England.     Unable  to  afford  metal- 
lic money,  they  were  compelled  to  pay  for  their  imports 
with   commodities   salable  in  the   European  markets. 
For  the  Northern  colonists,  beaver  skins  furnished  such 
a  commodity,  and  since  everybody  wanted  the  English 
goods,  the  beaver  skin  was  highly  desired  on  account  of 
its  purchasing  power. 

44.  Tobacco. — In  the  Virginia  colonies,  tobacco  was 
the  commodity  most  available  for  export  to  England. 
It  is  but  natural  that  it  should  come  to  have  an  artificial 
value  as  a  medium  of  exchange.     The  history  of  the 


EVOLUTION  OF  THE  MEDIUM  OF  EXCHANGE     39 

tobacco  currency  in  Virginia  reveals  a  great  many  of 
the  principles  underlying  the  science  of  money.  The 
story  is  very  well  told  by  Mr.  Horace  White  in  his  book, 
"Money  and  Banking" : 

In  1642  an  act  was  passed  forbidding  the  making  of  contracts 
payable  in  money,  thus  virtually  making  tobacco  the  sole  cur- 
rency. 

The  Act  of  1642  was  repealed  in  1656,  but  nearly  all  the  trad- 
ing in  the  province  continued  to  be  done  with  tobacco  as  the 
medium  of  exchange. 

In  1628  the  price  of  tobacco  in  silver  had  been  3s.  6d.  per 
pound  in  Virginia.  The  cultivation  increased  so  rapidly  that 
in  1631  the  price  had  fallen  to  6d.  In  order  to  raise  the  price, 
steps  were  taken  to  restrict  the  amount  grown  and  to  improve 
the  quality.  The  right  to  cultivate  tobacco  was  restricted  to 
1500  plants  per  poll.  Carpenters  and  other  mechanics  were  not 
allowed  to  plant  tobacco  "or  do  any  other  work  in  the  ground." 
These  measures  were  ineffective.  The  price  continued  to  fall. 
In  1639  it  was  only  3d.  It  was  now  enacted  that  half  of  the 
good  and  all  of  the  bad  should  be  destroyed,  and  that  there- 
after all  creditors  should  accept  40  Ib.  for  100;  that  the  crop 
of  1640  should  not  be  sold  for  less  than  12d.,  nor  that  in  1641 
for  less  than  2s.  per  pound,  under  penalty  of  forfeiture  of  the 
whole  crop.  This  law  was  ineffectual,  as  the  previous  ones  had 
been,  but  it  caused  much  injustice  between  debtors  and  creditors 
by  impairing  the  obligation  of  existing  contracts.  In  1645  to- 
bacco was  worth  only  l^d.  and  in  1655  only  Id.  per  pound. 

These  events  teach  us  that  a  commodity  which  is  liable  to  great 
and  sudden  changes  of  supply  is  not  a  desirable  one  to  be  used 
as  money. 

In  the  year  1666  a  treaty  was  negotiated  and  ratified  between 
the  colonies  of  Maryland,  Virginia,  and  Carolina,  to  stop  plant- 
ing tobacco  for  one  year  in  order  to  raise  the  price.  This  tem- 
porary suspension  of  planting  made  necessary  some  other  mode 
of  paying  debts.  It  was  accordingly  enacted  that  both  public 


40  MONEY  AND  BANKING 

dues  and  private  debts  falling  due  "in  the  vacant  year  from 
planting"  might  be  paid  in  country  produce  at  specified  rates. 

In  1683  an  extraordinary  series  of  occurrences  grew  out  of 
the  low  price  of  tobacco.  Many  people  signed  petitions  for  a 
cessation  of  planting  for  one  year  for  the  purpose  of  increasing 
the  price.  As  the  request  was  not  granted,  they  banded  them- 
selves together  and  went  through  the  country  destroying  tobacco 
plants  wherever  found.  The  evil  reached  such  proportions  that 
in  April,  1684,  the  Assembly  passed  a  law  declaring  that  these 
malefactors  had  passed  beyond  the  bounds  of  riot,  and  that  their 
aim  was  the  subversion  of  the  government.  It  was  enacted  that 
if  any  persons,  to  the  number  of  eight  or  more,  should  go  about 
destroying  tobacco  plants,  they  should  be  adjudged  traitors  and 
suffer  death. 

In  1727  tobacco  notes  were  legalized.  These  were  in  the  na- 
ture of  certificates  of  deposit  in  government  warehouses  issued 
by  official  inspectors.  They  were  declared  by  law  current  and 
payable  for  all  tobacco  debts  within  the  warehouse  district  where 
they  were  issued.  They  supply  an  early  example  of  the  dis- 
tinction between  money  on  the  one  hand,  and  government  notes, 
or  bank  notes,  on  the  other.  The  tobacco  in  the  warehouses  was 
the  real  medium  of  exchange.  The  tobacco  notes  were  orders 
payable  to  bearer  for  the  delivery  of  this  money.  They  were 
redeemable  in  tobacco  of  a  particular  grade,  but  not  in  any 
specified  lots.  Counterfeiting  the  notes  was  made  a  felony.  In 
1734  another  variety  of  currency,  called  "crop  notes,"  was  intro- 
duced. These  were  issued  for  particular  casks  of  tobacco,  each 
cask  being  branded  and  the  marks  specified  on  the  notes. 

45.  Summary  of  principles. — The  experience  of  the 
world  with  these  various  commodities  as  currency  has 
brought  out  some  fundamental  principles,  which  we 
have  mentioned  but  which  it  would  be  well  to  summarize, 
as  constant  use  must  be  made  of  them  in  stating  the 
more  complex  phases  of  the  subject.  One  of  the  most 
essential  requirements  for  money  as  a  medium  of  ex- 


EVOLUTION  OF  THE  MEDIUM  OF  EXCHANGE     41 

change  is  general  acceptability.  It  is  this  quality  which 
distinguishes  the  money  commodity  from  all  others. 
As  a  rule  a  commodity  becomes  more  acceptable  in 
exchange,  the  less  its  other  utilities  are  considered,  and 
the  wider  its  use  as  a  medium  of  exchange.  This  qual- 
ity of  acceptability  depends  either  upon  a  well-estab- 
lished tradition  or  upon  an  ultimate  market  where  it  is 
esteemed  for  its  want-satisfying  power.  Ornaments 
possessed  this  quality  to  a  high  degree  because  this  hu- 
man desire  was  almost  universal  among  primitive  peo- 
ples. In  the  case  of  beaver  skins  and  wampum,  the 
insatiable  demand  maintained  their  acceptability  of  ex- 
change. 

46.  Divisibility. — It    is    highly    desirable    that    the 
money  commodity  should  be  capable  of  division  into 
small  units  in  order  to  serve  as  a  medium  in  small  trans- 
actions.    This    quality   of   divisibility   was    absent    in 
beaver  skins  and  cattle.     Commodities  which  contain 
small  value  in  large  bulk,  which  with  the  amount  of  them 
necessary  to  make  even  a  very  ordinary  transaction  rep- 
resents so  great  a  volume  as  to  be  difficult  of  transporta- 
tion, are  unsuited  for  the  purpose  of  money.     When  the 
value  of  tobacco  fell,  the  difficulty  of  transporting  it 
added  to  its  other  disadvantages  as  money.     The  Chi- 
nese bronze  coins  of  the  present  day,  called  "cash,"  oc- 
casion great  inconvenience  to  travelers  who  must  carry 
a  moderate  sum  with  them.     Their  bulk  is  so  great  that 
separate  conveyances  must  be  used,  and  it  is  only  a  ques- 
tion of  time  when  they  will  be  eliminated  on  account 
of  their  cumbersomeness. 

47.  Uniformity. — Uniformity  is  another  highly  nec- 
essary quality  in  money.     When  the  estimates  of  value 
were  only  approximate  it  was  not  so  necessary  that  the 
units  of  the  currency  should  be  uniform,  but  when  the 


42  MONEY  AND  BANKING 

exchanging  became  more  general,  the  lack  of  uniform- 
ity in  the  units  became  a  serious  obstacle  to  their  gen- 
eral acceptability.  The  lack  of  this  very  necessary  qual- 
ity made  their  values  very  indeterminate  and  uncertain. 
Beaver  skins  were  unsuited  for  the  purpose  largely  on 
this  account.  Tobacco  was  less  so. 

48.  Cognizability. — Closely  connected  with  the  qual- 
ity of  uniformity  is  that  of  cognizability,  that  is,  the 
possession  of  certain  qualities  which  are  distinctive  and 
easily  recognized,  either  on  account  of  color,  texture  or 
weight.     Wampum  which  possesses  so  many  of  the  other 
qualities  desirable  in  money  failed  in  this  important  par- 
ticular; they  could  be  easily  counterfeited.     Lack  of 
this  quality  of  cognizability  can  be  overcome  by  the  use 
of  some  mark  which  is  either  difficult  to  counterfeit  or 
which  can  be  protected  by  severe  penalties.     The  old 
laws  which  made  counterfeiting  a  capital  crime,  pun- 
ishable by  death,  were  justified  when  the  necessity  for 
maintaining  the  quality  of  cognizability  in  the  currency 
is  appreciated.     Most  of  the  early  currencies  were  un- 
fitted for  that  use  because  of  their  liability  to  deteriora- 
tion.    A  commodity  which  has  this  defect  is  unsuited  as 
a  store  of  value,  and  the  moment  the  deterioration  be- 
gins to  take  place,  it  loses  the  quality  of  acceptability. 

49.  Stability   of  value. — Most  of  these   defects   in 
money  have  been  eliminated  by  the  use  of  metallic  coins, 
and  later  by  the  use  of  credit.     There  is  one  quality, 
however,  which  metallic  currencies  fail  to  possess,  that 
is,  stability  of  value.     The  whole  question  of  the  stand- 
ards and  the  whole  controversy  over  silver  and  gold 
arises  out  of  this  characteristic  lack  of  stability  of  value, 
a  principle  which  we  shall  discuss  at  length  presently. 
The  final  result  of  this  process  of  evolution  in  money,  the 
gradual  discredit  of  the  unfit  and  the  extension  of  the 


EVOLUTION  OF  THE  MEDIUM  OF  EXCHANGE     43 

use  of  commodities  possessing  more  of  these  desirable 
qualities,  was  the  universal  use  of  the  metals  as  money. 
Beginning  with  the  commoner  varieties  of  metals  like 
bronze  and  iron  in  the  form  of  the  utensils  which  serve 
a  useful  purpose  other  than  exchange,  we  may  trace 
down  the  development  to  the  coin  which  has  no  other 
purpose  than  to  be  used  as  a  medium  of  exchange. 
Adam  Smith  speaks  of  a  village  in  Scotland  in  his  day 
where  nails  were  used  as  money.  The  general  use  of 
bullets  among  the  American  pioneers  in  the  chase  and 
in  warfare  against  the  Indians  made  them  good 
"change"  in  the  early  days  of  New  England.  In  the 
histories  of  Greece,  we  read  of  the  huge  and  heavy  iron 
coins  of  Sparta,  which  survived  beyond  their  time  on  ac- 
count of  the  hostility  of  the  Spartans  to  trade.  They 
seemed  purposely  to  have  retained  a  most  unsuitable 
form  of  money  for  the  purpose  of  hindering  exchange. 
The  developments  of  better  methods  in  mining  and 
smelting  the  commoner  metals  such  as  bronze,  iron 
and  tin  made  them  unsuitable  for  the  currencies  in  any 
form.  Their  defect  was  in  their  cumbersomeness  and 
in  the  difficulty  of  carrying  them  about.  The  process  of 
elimination  began  with  the  cheaper  and  the  heavier  met- 
als, until  at  last  the  sole  survivors  were  silver  and  gold, 
except  for  the  very  smallest  of  coins. 


CHAPTER  V 

EVOLUTION  OF  THE  STANDARD  OF  VALUE 

50.  Metal  standards  the  fittest  to  survive. — The  his- 
tory of  money  has  illustrated  very  faithfully  the  law  of 
evolution  and  the  survival  of  the  fittest.     After  all  the 
commodities  mentioned  in  the  preceding  chapter  had 
been  tried  and  found  wanting,  the  world  finally  settled 
upon  silver  and  gold  as  the  most  suitable  materials  for 
money.     In  the  first  place  they  have  always  had  a  great 
attraction  in  the  eyes  of  mankind  for  use  as  ornament 
because  of  their  natural  beauty.     Their  scarcity  and  the 
difficulty  with  which  they  are  produced  gives  them  a 
certain  stability  of  value,  which  was  wanting  in  most  of 
the  earlier  forms.     Either  of  the  metals  in  its  pure  state 
is  homogeneous  and  practically  of  one  quality,  so  that 
every  single  quantity,  no  matter  whether  it  is  mined  in 
the  Klondike  or  in  South  Africa,  is  almost  the  same  as 
any  other  for  all  practical  purposes.     Unless  the  metal 
is  mixed  with  alloys,  there  is  no  uncertainty  as  to  its 
quality. 

51.  Good  qualities. — Both  metals  are  fairly  durable, 
although  not  so  much  so  as  iron.     This  defect  is  par- 
tially remedied  by  the  mixing  with  gold  or  silver  of  some 
harder  metal  in  manufacturing  coins.     Gold  and  silver 
may  be  divided  into  the  smallest  parts  without  sacri- 
ficing any  of  its  value,  thus  fitting  it  for  peculiar  use  in 
making    transactions    of    varying    magnitude.     They 
have  large  value  in  small  bulk,  although  the  increasing 
cheapness  of  silver  led  to  its  partial  discontinuance  as  a 

44 


EVOLUTION  OF  THE  STANDARD  OF  VALUE      45 

money  metal  within  recent  years.  These  metals  are 
peculiarly  adapted  to  the  process  of  coinage,  and  capa- 
ble of  being  changed  in  form,  size  and  shape  without  a 
specially  difficult  process  of  manufacturing. 

To  avoid  the  division  of  silver  and  gold  into  quantities 
so  small  as  to  be  impracticable  in  handling,  the  baser 
metals  are  generally  used  for  coins  of  minor  value  where 
the  defect  of  small  value  in  large  bulk  does  not  apply. 

52.  Platinum  unsuccessful  as  money. — Of  the  more 
expensive  metals  platinum  is  the  only  one  which  has 
been  tried  as  money.     In  1828  the  Russian  Government, 
which  owned  the  principal  platinum  mines,  began  to 
coin  this  metal  into  pieces  of  three,  six  and  twelve  ru- 
bles,   a   ruble   being   worth    approximately   50    cents. 
Platinum  has  several  qualities  which  fit  it  for  use  as 
money,  particularly  its  durability  and  its  great  density, 
which  makes  it  easily  distinguishable  on  account  of  its 
weight.     Furthermore  it  oxidizes  very  slowly.    The  ex- 
periment, however,  revealed  several  fatal  objections  to 
its  use  as  coin.     There  is  no  great  amount  of  it  in  use 
in  commerce,  hence  the  value  of  it  is  likely  to  be  very 
unstable.     Because  of  its  extremely  high  melting  point, 
the  cost  of  manufacturing  the  coins  was  very  great,  and 
it  could  not  be  easily  converted  from  bullion  to  coin  and 
from  coin  to  bullion,   a   feature  which  renders   gold 
and  silver  very  suitable  for  money.    These  objections  in- 
duced the  Russian  Government  to  abandon  the  experi- 
ment in  1845. 

53.  Objections  to  gold  and  silver. — Gold  and  silver 
in  bullion  form  are  by  no  means  the  ideal  money.     They 
are  difficult  to  identify  at  sight  without  the  use  of  tests, 
which  are  too  elaborate  for  ordinary  use,  so  that  it  is 
easy  to  counterfeit  them.     They  also  are  affected  by 
wear  and  the  question  of  loss  of  weight  in  handling  has 


46  MONEY  AND  BANKING 

at  times  been  a  serious  one.  In  recent  times  especially, 
their  lack  of  stability  of  value  has  created  monetary 
problems  of  a  serious  nature,  as  for  instance  the  Free 
Silver  agitation  during  the  last  quarter  of  the  past  cen- 
tury. 

54.  Coinage. — The  first  two  defects  named,  i.  e.,  the 
susceptibility  to  wear  and  counterfeiting,  have  been 
overcome  to  a  certain  extent  by  coinage.     The  first  at- 
tempts at  coinage  were  probably  the  simple  stamping  of 
a  quantity  of  metal  with  a  symbol  or  character,  indicat- 
ing its  weight  in  order  to  avoid  a  repeated  weighing. 

To  Pheidon,  king  of  Argos,  is  generally  attributed 
the  first  coinage  of  the  modern  form.  He  is  reported  to 
have  stamped  both  copper  and  silver  money  in  the  Island 
of  .ZEgina,  in  order  to  facilitate  commerce;  and  having 
the  word  of  authority  from  Mr.  Grote  we  may  rest  as- 
sured as  to  the  truth  of  the  account. 

55.  Names  of  coins. — The  name  of  the  English  unit 
of  money — the  pound  sterling — clearly  indicates  that  it 
was  originally  a  pound  weight  of  silver,  just  as  the  old 
French    coin,    livre    (the    French    word    for    pound) 
meant  a  similar  weight  of  silver.     The  symbols  stamped 
upon  some  of  the  earliest  coins  indicated  that  they  were 
the  equivalent  of  some  earlier  standard,  as  for  instance 
the  ox  stamped  upon  the  Grecian  coins  pointed  back 
to  the  use  of  cattle  as  the  standard  of  value. 

It  was  probably  not  long  before  this  convenient 
method  of  stamping  pieces  of  metal  led  to  abuses.  It 
is  quite  likely  that  the  less  scrupulous  merchants  placed 
the  stamp  upon  smaller  quantities  of  the  metal  or  sub- 
tracted from  the  stamped  pieces  part  of  their  substance. 
This  practice  soon  made  the  stamp  very  unreliable.  To 
circumvent  this  lucrative  practice,  the  stamp  upon  the 
coin  was  elaborated  to  cover  the  whole  face  of  the  metal, 


EVOLUTION  OF  THE  STANDARD  OF  VALUE      47 

so  as  to  make  difficult  the  abstraction  of  any  portion  of 
it,  and  besides  to  inscribe  on  the  coin  the  name  of  the 
person  certifying  the  weight.  To  prevent  the  wearing 
away  of  the  metal,  it  became  customary  to  mix  in  the 
coin  some  harder  metal,  called  alloy.  Again  this  con- 
venient device  was  abused,  and  it  was  found  profitable 
to  introduce  into  the  coin  a  greater  amount  of  alloy  than 
was  customary.  Thereupon  it  became  necessary  to  in- 
dicate in  some  way  the  fineness  of  the  metal. 

56.  Requirements  of  good  coinage. — At  this  stage  of 
coinage  three  considerations  had  to  be  observed :  It  was 
necessary  that  the  stamp  upon  the  coin  should  certify 
that  there  was  a  certain  amount  of  metal  of  a  certain 
fineness  in  the  coin,  that  none  of  the  metal  had  been  ab- 
stracted after  the  stamping  of  the  piece,  that  the  de- 
vice cover  the  whole  face  of  the  coin,  that  it  was 
guaranteed  by  some  reliable  person,  and  that  it  should 
be  difficult  to  counterfeit.  The  great  advantage  to  com- 
merce in  having  good  coinage  led  to  the  gradual  restric- 
tion of  the  right  to  coin  money  to  a  few  reliable  persons, 
and  finally  to  the  sovereign  himself. 

This  restriction  of  coinage,  however,  did  not  elim- 
inate the  abuses  which  we  have  mentioned,  for  the  royal 
authorities  for  many  centuries  made  large  profits  by 
debasing  the  coinage,  both  by  reducing  the  size  of  the 
coins  and  by  increasing  the  amount  of  the  alloy  in  them. 
This  fact  can  be  easily  demonstrated  by  reference  to  the 
coins  of  to-day.  The  English  pound  sterling,  which 
originally  represented  a  pound  of  silver,  finally  came  to 
represent  about  half  that  amount.  The  people  became 
so  accustomed  to  receiving  coins  according  to  their  face 
and  without  reference  to  their  weight  that  the  debased 
coin  of  similar  weight  had  the  same  purchasing  power 
as  ever,  The  needy  monarch  could  melt  up  the  old  coins 


48  MONEY  AND  BANKING 

and  recoin  the  metal  into  a  considerably  larger  number 
of  new  pieces  bearing  the  same  name  and  thus  increase 
the  resources  of  his  treasury  at  slight  expense.  This 
was  equivalent  to  a  tax  upon  the  people,  but  it  was  so 
indirect  that  it  passed  without  protest.  Henry  VIII 
of  England  distinguished  himself  by  repeated  in- 
dulgence in  this  profitable  practice. 

Fraudulent  abrasion  and  clipping  of  coins  were  a 
great  nuisance  in  the  seventeenth  century.  The  silver 
coins  circulating  in  the  American  colonies  were  chiefly 
Spanish  dollars — sometimes  called  "pieces-of-eight,"  be- 
ing of  the  value  of  eight  reals — and  their  fractions. 
They  were  brought  in  by  trade  with  the  West  Indies. 
Some  were  coined  in  Spain  and  others  in  the  Spanish- 
American  colonies.  At  their  best  they  were  not  uni- 
form in  either  weight  or  fineness,  and  they  had  been 
much  tampered  with  by  sweating  and  clipping.  The 
heavier  ones  were  constantly  culled  out  to  make  remit- 
tances abroad,  since  they  were  received  in  England  by 
weight  only.  Those  which  remained  in  the  colonies 
grew  lighter  and  lighter,  until,  in  1652,  the  pieces  in 
circulation  had  lost  about  one-fourth  of  their  original 
weight. 

57.  Standard  of  value. — Up  to  this  point  we  have 
studied  the  subject  of  metallic  money  from  the  stand- 
point of  its  function  as  a  medium  of  exchange.  The 
principal  points  involved  have  been  the  convenient  size 
of  the  coin,  its  genuineness,  accuracy,  composition  and 
weight.  The  question  of  the  function  of  metallic 
money  as  a  standard  of  value  involves  quite  different 
principles. 

By  a  standard  of  value  we  mean  the  use  of  a  metal  as 
a  measure  for  the  values  of  all  other  commodities.  The 
one  essential  quality  which  fits  a  metal  to  be  used  as  a 


EVOLUTION  OF  THE  STANDARD  OF  VALUE      49 

standard  is  stability  of  value.  Since  value  is  the  result 
of  adjustment  between  supply  and  demand,  it  is  obvious 
that  our  standard  metal  must  not  be  subject  to  excessive 
fluctuations  in  either  of  these  particulars.  The  prin- 
cipal monetary  problems  of  the  past  century  have  arisen 
out  of  controversies  regarding  the  standard. 

In  ancient  times  both  gold  and  silver  were  used  as  a 
standard,  and  no  difficulty  arose  therefrom,  principally 
because  there  were  no  great  changes  in  the  supply  of 
these  metals  and  because  trade  was  so  poorly  developed 
that  divergencies  in  values  were  not  important  enough 
to  create  serious  inconveniences.  It  is  only  in  communi- 
ties where  industry  and  commerce  are  highly  organized 
that  small  changes  in  the  measure  of  value  are  notice- 
able. The  case  is  similar  to  that  of  engineering;  for 
example,  in  earlier  times  of  cruder  construction  there 
was  practically  no  need  of  very  accurate  measuring  ap- 
paratus. Differences  of  a  fraction  of  an  inch  or  milli- 
meter could  be  disregarded.  With  improved  technique 
and  finer  problems,  it  is  necessary  to  have  the  utmost 
accuracy  in  measurement.  The  standard  of  value  is  a 
measuring  apparatus  for  values,  and  it  is  only  under 
highly  developed  commercial  conditions  that  minute  ac- 
curacy is  essential. 

58.  Double  standard  possible  until  last  century.— 
During  the  Middle  Ages,  gold  became  so  scarce  that  sil- 
ver was  practically  the  only  coinage,  and  so  the  Eu- 
ropean nations  were  on  a  silver  standard.  The  fall  in 
the  value  of  silver  about  the  fifteenth  century  and  on 
created  a  demand  for  coins  of  greater  value  in  small 
bulk,  and  as  there  was  a  greater  production  of  gold  at 
this  time,  the  use  of  gold  coins  together  with  the  silver 
became  more  common. 

It  is  impossible  to  understand  the  intricacies  of  the 
Vii-4 


50  MONEY  AND  BANKING 

standard  question  until  we  know  just  how  the  values  of 
the  coins  are  determined.  Both  silver  and  gold  are  used 
to  such  an  extent  in  the  arts  that  their  value  is  deter- 
mined in  large  measure  by  the  demand  for  them  there 
in  relation  to  the  supply.  The  mints  are  always  obliged 
to  draw  their  supply  of  bullion  from  the  open  market, 
and  unless  they  offer  the  market  price  they  are  unable 
to  obtain  any. 

Suppose,  for  example,  that  the  supply  of  silver  grad- 
ually diminishes  while  the  demand  for  it  in  the  market  is 
maintained.  Naturally,  the  producers  of  silver  will  be 
able  to  obtain  better  terms  for  it  than  before.  Jewelers 
and  other  persons  wishing  to  use  silver  in  their  business 
will  melt  up  silver  coins  instead  of  purchasing  the  bullion 
at  the  higher  price  in  the  coinage.  Under  these  condi- 
tions, people  would  begin  to  discriminate  between  silver 
and  gold  coins,  selling  the  silver  coins  to  the  jewelers  at 
a  slight  premium  which  they  would  probably  offer  for 
them.  The  Government  would  be  unable  to  get  silver 
for  coinage  purposes  unless  they  gave  a  much  larger 
sum  in  gold  for  it,  and  if  they  simply  gave  back  the 
silver  in  the  form  of  coins,  these  coins  would  quickly 
retire  from  circulation. 

59.  Gresham's  Law. — This  principle  is  called  Gres- 
ham's  Law,  named  from  an  official  in  the  reign  of 
Queen  Elizabeth,  who  first  observed  this  tendency  of 
people  to  discriminate  between  two  coins  of  the  same 
nominal  value.  The  simplest  statement  of  this  law  is 
that  the  cheaper  money  tends  to  drive  out  the  dearer, 
that  is  to  say,  when  the  people  for  any  reason  begin  to 
discriminate  between  two  coinages,  they  will  invariably 
pay  out  the  inferior  and  will  hoard  the  better,  thus  re- 
moving it  from  circulation. 

The  only  remedy  for  this  condition  would  be  for 


EVOLUTION  OF  THE  STANDARD  OF  VALUE      51 

mints  to  constantly  alter  the  amount  of  metal  in  the 
coins  to  correspond  to  their  commodity  value  in  the  mar- 
ket. Gold  and  silver  are  so  easily  transported  from  one 
country  to  another  that  changes  in  their  value  at  any 
particular  place  will  quickly  spread  throughout  the  com- 
mercial world.  For  example,  if  a  new  silver  mine  is 
discovered  in  South  America,  the  increased  supply  of 
silver  at  that  place  will  lower  its  value;  the  producers 
will  offer  it  on  easier  and  easier  terms  in  exchange  for 
gold  or  anything  else  of  value.  Silver  will  again  begin 
to  be  exported,  for  it  commands  a  higher  price  abroad 
than  it  does  at  home,  but  the  result  of  thus  increasing 
the  supply  in  other  countries  will  lower  its  value  there 
until  a  new  equilibrium  is  established. 

It  is  of  course  impossible  for  the  mints  to  continually 
alter  the  quantity  of  metal  in  the  coins  to  correspond  to 
their  market  values.  Even  if  they  did  so,  the  old  coins 
in  circulation  would  have  a  value  either  greater  or  less 
than  their  face,  which  would  cause  one  or  the  other  of 
them  to  retire  from  circulation. 

60.  Mistakes  of  early  legislators. — This  tendency  of 
metals  to  fluctuate  in  value  was  not  understood  until  re- 
cently, and  the  governments  were  constantly  trying  va- 
rious expedients  to  force  the  circulation,  of  both  metals 
in  the  face  of  natural  laws  to  the  contrary.  As  is  usual 
with  legislators  and  officials  who  are  dealing  with  a  mat- 
ter which  they  do  not  understand,  they  sought  to  deal 
with  the  symptoms  rather  than  the  cause  of  the  trouble. 
To  this  end  they  passed  laws  forbidding  trade  in  the 
precious  metals.  They  placed  obstacles  in  the  way  of 
export  and  import.  They  made  melting  the  coins  a 
criminal  offense.  As  is  usual  with  unscientific  laws  of 
this  character,  they  were  impossible  of  execution,  and 
were  constantly  evaded. 


52  MONEY  AND  BANKING 

61.  Experience  of  England  with  double  standard. — 
The  true  solution  of  these  difficulties  was  first  reached 
in  England.  This  country  had  had  her  share  of  the 
loss  and  vexation  due  to  changes  of  the  ratio.  She  had 
also  visited  cruel  punishments  on  individuals  for  melting 
and  exporting  the  precious  metals.  All  attempts  to  en- 
force these  foolish  laws  were  eventually  abandoned,  and 
it  came  to  pass  in  the  reign  of  Charles  II  that  the  guinea 
of  gold,  although  proclaimed  by  royal  authority  to  be 
the  equivalent  of  20s.  in  silver,  passed  in  trade  for  21s., 
and  no  attempt  was  made  by  the  government  to  inter- 
fere. The  guinea  remained  as  a  trade  coin  till  the  third 
year  of  George  I  (1717),  when  another  proclamation 
was  issued  making  it  legally  equal  to  21s.,  at  which  fig- 
ure the  ratio  to  silver  was  about  15  1-5  to  1. 

As  gold  was  slightly  overrated  at  the  ratio  of  15  1-5, 
there  was  a  tendency  to  export  silver ;  and  for  this  pur- 
pose the  full-weight  coins  were  selected.  So  it  came 
about  in  the  course  of  half  a  century  that  the  only 
silver  coins  remaining  in  circulation  were  those  which 
had  been  much  reduced  in  weight  by  abrasion  or  by 
fraudulent  clipping.  The  evil  became  so  intolerable 
that  Parliament,  in  1774,  passed  a  law  providing  that 
silver  coin  should  not  be  legal  tender  for  more  than  £25 
in  one  payment,  except  by  weight  at  the  rate  of  5s.  2d. 
per  ounce.  It  was  enacted  at  the  same  time  that  gold 
coins  deficient  in  weight  should  be  called  in  and  recoined, 
and  that  thereafter  such  coins,  if  under  a  certain  weight, 
should  not  be  legal  tender  at  all.  The  restriction  of  the 
legal  tender  of  silver  was  to  continue  two  years.  The 
expectation  of  Parliament  was  that  some  effectual  and 
permanent  steps  would  be  taken  to  deal  with  the  evil 
of  light  coins  in  that  interval,  but  since  nothing  was 
done,  the  act  of  1774  was  renewed  in  1776  for  two  years 


EVOLUTION  OF  THE  STANDARD  OF  VALUE      53 

more.  In  1778  it  was  renewed  for  seven  years,  and 
then  by  repeated  renewals  it  was  carried  forward  to 
1798.  Another  clause  was  now  added  that  no  more 
silver  should  be  coined  at  the  mint  for  private  persons. 

62.  Adoption  of  single  gold  standard  unintentional. 
— The  significance  of  this  legislation  was  not  perceived 
at  the  time.  It  had  not  been  the  intention  of  Parlia- 
ment to  establish  the  single  gold  standard.  The  ques- 
tion of  standard  was  not  under  consideration  at  all. 
What  Parliament  did  in  1774  was:  (1)  to  put  gold 
coin  in  a  state  of  perfection  by  recoining  the  defective 
pieces  and  making  light  coins  unavailable  in  payments 
thereafter;  (2)  to  limit  the  legal-tender  faculty  of  the 
silver  money  then  in  circulation.  The  mint  was  still 
open,  and  anybody  could  have  silver  bullion  coined  into 
money  of  full  weight  and  full  legal  tender.  But  since 
silver  was  undervalued  at  the  ratio  of  15  1-5,  nobody 
would  take  it  to  the  mint.  Thus  all  the  conditions  of 
the  single  gold  standard  were  in  practical  operation 
without  any  fixed  intention  of  Parliament  to  bring  it 
about,  or  any  knowledge  that  it  had  been  done. 

It  was  noticed,  however,  that  the  inconveniences  of  a 
shifting  ratio  had  disappeared.  There  was  plenty  of 
gold  money  for  large  transactions  and  of  silver  money 
for  small  ones.  Although  the  silver  coins  were  de- 
ficient in  weight,  they  answered  the  purposes  of  small 
change.  After  the  experience  of  a  quarter  of  a  cen- 
tury, Parliament  and  people  were  convinced  that  the  Act 
of  1774,  although  adopted  as  a  temporary  measure, 
ought  to  be  made  permanent.  Accordingly  it  was 
made  so  in  1799. 

Yet  it  was  not  until  1816  that  the  true  philosophy  of 
the  step  was  well  enough  understood  to  secure  its  en- 
actment into  a  settled  law.  In  that  year  it  was  enacted 


54.  MONEY  AND  BANKING 

that  the  gold  coin  of  the  realm,  when  of  full  weight, 
should  be  full  legal  tender  and  should  be  coined  for 
private  persons  to  any  amount,  and  that  silver  coin 
should  not  be  legal  tender  for  more  than  40s.  in  one 
payment,  and  should  be  coined  only  on  government  ac- 
count and  should  be  reduced  in  weight  6  per  cent.  This 
law,  which  established  the  single  gold  standard,  remains 
in  force  to  the  present  day. 

It  seems  to  be  the  singular  good  fortune  of  England 
to  blunder  upon  or  have  thrust  upon  her  good  institu- 
tions which  other  countries  acquire  only  after  much 
conscious  effort  and  perhaps  revolution.  Besides  the 
gold  standard  a  great  many  excellent  features  of  gov- 
ernment— the  dual  houses  of  Parliament,  the  respon- 
sibility of  the  Cabinet  to  the  Commons,  republican  gov- 
ernment under  the  form  of  a  monarchy,  etc.,  might  be 
cited  on  this  point. 

63.  Mintage. — The  key  to  the  understanding  of  the 
complex  problems  of  the  standards  is  a  clear  conception 
of  the  minting  of  coinage  and  of  the  influence  of  the 
mints  upon  values  of  the  precious  metals.  A  mint  is  a 
place  where  certain  definite  quantities  of  the  precious 
metals  are  stamped  with  a  device  or  inscription,  indi- 
cating the  exact  quantity  of  metal  in  them.  As  before 
mentioned,  the  earliest  inscriptions  were  literal  state- 
ments of  the  weight  of  the  metal  contained  therein ;  the 
English  pound  was  a  pound  of  silver,  the  English 
penny,  a  pennyweight  of  silver.  The  sole  function  of 
the  mint  was  to  put  the  metal  into  a  form  more  con- 
venient for  circulation.  It  affected  the  value  of  the 
metals  only  so  far  as  this  stamping  increased  their  utili- 
ity  as  a  medium  of  exchange  and  created  an  additional 
demand  for  them. 

The  precious  metals  have  a  market  value  exactly  the 


EVOLUTION  OF  THE  STANDARD  OF  VALUE      55 

same  as  any  other  commodities,  and  this  market  value 
fluctuates  according  to  the  laws  of  supply  and  demand. 
When  there  is  only  one  metal  in  use  as  money,  the  fluc- 
tuations in  its  market  value  can  be  measured  only  by 
the  rise  and  fall  of  values  of  other  things.  The  name 
"dollar,"  "pound  sterling,"  "franc,"  "mark,"  etc.,  are 
simply  terms  indicating  weight,  not  value.  The  name 
.  "dollar"  for  example  is  merely  another  name  for  a  cer- 
tain definite  weight  of  gold,  i.  e.,  23.22  grains  of  pure 
gold.  A  confusion  of  thought  arises  because  the  values 
of  everything  else  are  indicated  by  comparison  with  the 
dollar  of  gold.  Because  the  amount  of  gold  in  the  dol- 
lar never  changes  except  by  legislative  enactment,  peo- 
ple come  to  think  of  the  value  of  gold  as  being  fixed 
and  unchanging.  In  a  later  chapter  on  the  relation  be- 
tween gold  and  prices,  we  shall  work  out  this  idea  more 
exhaustively. 

64.  Legal  tender. — In  the  Middle  Ages  when  there 
were  a  great  variety  of  coinages  in  concurrent  circula- 
tion, it  was  necessary  that  there  should  be  some  under- 
standing as  to  the  relative  values  of  this  heterogenous 
coinage.  Accordingly  the  duty  was  imposed  upon  the 
government  of  prescribing  the  value  of  all  other  coins 
in  terms  of  some  one  particular  domestic  coin.  These 
royal  proclamations  of  the  value  of  coins  really  had  a 
force  of  legal  tender  enactments,  because  a  creditor  was 
compelled  by  courts  to  receive  any  of  these  coins  at  its 
posted  value.  Legal  tender  means  any  medium  of  ex- 
change which  may  be  tendered  in  payment  of  debt,  and 
which  must  be  received  by  the  creditor  whether  he  is 
willing  or  not. 

It  was  observed  early  that  there  was  a  tendency 
for  certain  classes  of  coins  at  certain  times  to  disappear 
from  circulation.  They  were  either  hoarded  or  melted 


56  MONEY  AND  BANKING 

up  for  use  in  the  manufacture  of  jewelry  or  plate  or 
they  were  exported.  In  order  to  prevent  this  the  mints 
frequently  reduced  the  amount  of  metal  in  the  coin  or 
attempted  to  check  the  tendency  by  laws  prohibiting  ex- 
porting or  melting  of  the  coins.  Only  the  former  of 
these  measures  was  efficacious  in  checking  these  tend- 
encies. Before,  however,  the  constant  altering  of  the 
coinage  induced  great  confusion  in  trade. 

65.  History  of  coinage  in  the  United  States. — The 
history  of  the  coinage  of  gold  and  silver  in  the  United 
States  is  one  of  the  most  instructive  illustrations  of  the 
laws  which  govern  the  fluctuations  in  value  of  the  pre- 
cious metals.     The  first  secretary  of  the  treasury  and 
of  the   Constitution  was  Alexander  Hamilton,  upon 
whom  devolved  the  duty  of  creating  a  plan  for  a  mon- 
etary and  banking  system  for  the  new  country.     The 
medium  of  exchange  in  circulation  at  that  time  was 
principally  Spanish  and  English  silver  coins,  or  paper 
money  of  the  colonies.     The  power  given  to  Congress 
by  the  Constitution  of  regulating  the  value  of  foreign 
coins  was  more  important  at  that  time  because  of  the 
great  variety  in  circulation.     It  was  necessary  to  have 
some  authoritative  valuation  in  order  that  payments 
might  be  made  without  requiring  the  parties  to  come  to 
agreement  as  to  the  precise  means  of  payment. 

66.  First  ratio  of  silver  to  gold,  15:1. — It  was  part  of 
the  plan  of  Hamilton  to  establish  an  United  States  mint, 
so  that  the  country  might  be  supplied  with  an  adequate 
amount  of  United  States  coins  in  the  shortest  possible 
time,  and  thus  do  away  with  the  confusion  of  the  miscel- 
laneous coinage.     He  thought  it  necessary  to  coin  both 
gold  and  silver  in  order  that  this  purpose  might  be  con- 
summated as  rapidly  as  possible.     He  fixed  upon  the 
ratio  of  15  to  1  as  approximating  most  closely  the  mar- 


EVOLUTION  OF  THE  STANDARD  OF  VALUE     57 

ket  values  of  the  metals  at  that  time.  The  unit  of  value, 
the  dollar,  was  decided  upon  because  of  the  familiarity 
of  the  people  with  the  Spanish  dollar,  and  their  custom 
of  quoting  prices  in  that  standard.  The  opening  of  the 
mints  to  the  coinage  of  silver  and  gold  at  the  ratio  15 
to  1  meant  the  free  coinage  of  both  metals.  The  mint 
stood  ready  to  accept  gold  and  silver,  to  convert  it  into 
coins,  and  return  these  coins  to  the  person  bringing  the 
metal,  charging  him  a  very  small  fee  for  the  alloys  used 
to  harden  the  coins. 

67.  Inaccuracy  of  the  ratio  and  its  effects. — The  plan 
did  not  work  out  as  Hamilton  had  intended.  In  the 
first  place  the  ratio  of  15  to  1  had  ceased  to  represent 
the  market  ratio,  when  the  mint  was  finally  ready  for 
coinage  about  two  or  three  years  later.  According  to 
the  great  European  authority  on  the  market  values  of 
the  precious  metals,  Soetbeer,  the  actual  market  ratios 
were  as  foUows:  15.37  to  1  in  1794,  15.55  to  1  in  1795, 
15.65  to  1  in  1796,  15.41  to  1  in  1797,  15.59  to  1  in 
1798,  15.74  to  1  in  1799,  15.68  to  1  in  1800,  15.46  to  1 
in  1801,  and  15.26  to  1  in  1802.  This  change  in  the 
market  ratio  meant  that  silver  had  declined  in  value  rel- 
ative to  gold. 

Under  these  circumstances  nobody  would  be  so  fool- 
ish as  to  take  gold  to  the  mint  to  be  coined.  It  would 
be  much  more  profitable  to  take  that  gold  and  pur- 
chase silver  with  it  in  the  market,  and  then  to  take  the 
silver  to  the  mint  and  have  it  coined  into  more  dollars 
than  the  gold  would  have  made,  and  each  capable  of 
purchasing  the  same  amount  of  commodities  as  a  gold 
dollar.  To  make  this  proposition  as  clear  as  possible, 
let  us  take  a  concrete  example. 

Suppose  a  dealer  in  bullion  has  one  pound  of  gold. 
If  he  wishes  to  convert  it  into  a  means  of  payment,  he 


58  MONEY  AND  BANKING 

may  do  one  of  two  things;  first,  he  may  take  it  to  the 
mint  and  have  it  coined  into  approximately  250  dollars ; 
second,  he  may  exchange  the  gold  bullion  for  silver  bul- 
lion in  the  European  market.  If  the  market  ratio  hap- 
pens to  be  151/2  at  this  time,  he  will  get  in  exchange  15% 
pounds  of  silver.  This  silver  he  may  take  to  the  mint 
and  have  it  coined  into  approximately  260  dollars,  each 
of  which  is  just  as  good  as  any  gold  dollar  for  the  pur- 
pose of  trade.  Under  these  circumstances,  why  should 
anybody  take  gold  to  the  mint  when  there  were  always 
dealers  who  were  eager  to  make  the  profit  which  could 
be  had  by  purchasing  his  gold  bullion  for  silver  dollars, 
exporting  the  gold  to  buy  foreign  silver,  and  then  hav- 
ing the  imported  silver  coined  in  order  to  buy  more  gold 
bullion?  Here  we  have  an  endless  chain,  automatically 
causing  an  export  of  gold  and  an  import  of  silver.  Un- 
der these  circumstances  no  gold  was  coined,  of  course. 

68.  Disappearance  of  the  silver  dollars. — Hamilton's 
idea  of  supplying  this  new  country  with  coins  of  its  own 
mintage  was  further  frustrated  by  another  peculiar  con- 
dition. It  was  very  soon  noticed  that  in  spite  of  the  coin- 
age of  silver  dollars  at  the  mint  they  did  not  seem  to  re- 
main in  circulation  for  long.  Instead  the  old  Spanish 
coinage  continued  to  be  the  current  money.  Of  these 
Spanish  and  other  foreign  coins,  only  those  which  were 
clipped  and  mutilated  were  current.  Perfect  coins 
were  either  soon  reduced  to  this  same  condition  or  disap- 
peared from  circulation.  The  Spanish  silver  coins  were 
at  this  time  full  legal  tender  along  with  the  United 
States  coins.  In  their  perfect  condition  they  were 
slightly  heavier  than  the  American  coin.  Both  in  this 
country  and  in  the  West  Indies,  with  whom  at  that  time 
we  had  a  very  extensive  trade,  both  coins  passed  at  their 
face  value  without  any  discrimination.  Shrewd  traders 


EVOLUTION  OF  THE  STANDARD  OF  VALUE      59 

found,  however,  that  they  could  make  a  profit  exporting 
the  new  United  States  silver  dollars,  exchanging  them 
in  the  West  Indies  for  the  heavier  Spanish  dollars,  melt- 
ing these  heavier  dollars  into  bullion,  bringing  the  bul- 
lion to  the  United  States  and  having  it  coined  into  more 
than  the  original  number  of  dollars. 

When  the  officers  of  the  mint  discovered  that  the 
coinage  of  silver  dollars  was  simply  adding  to  the  profit 
of  these  bullion  dealers  instead  of  supplying  the  coun- 
try with  currency,  they  suspended  the  coinage  of  the  sil- 
ver dollar  in  1806.  This  unsatisfactory  state  of  the  me- 
tallic currency  of  the  country  was  not  so  serious  because 
of  the  almost  universal  use  of  paper  money  at  that  time. 

FLUCTUATIONS  OF  MARKET  RATIO  BETWEEN  GOLD  AND  SILVER.! 
Year.  Ratio.     Year.  Ratio.     Year.  Ratio. 


1803 

1830  

....  15.82 

1858  

15.38 

to 

1831  

....  15.72 

1859  

15.19 

1804  

15.41 

1832  

....  15.73 

1860  

15.29 

1805  

15.79 

1833  

....  15.93 

1861  

15.26 

1806  

15.52 

1834  

....  15.73 

1862  

15.35 

1807  

15.43 

1835  

....  15.80 

1863  

15.37 

1808  

16.08 

1836  

....  15.72 

1864  

15.37 

1809  

15.96 

1837  

....  15.83 

1865  

15.44 

1810  

15.77 

1838  

....  15.85 

1866  

15.43 

1811  

15.53 

1839 

1867  

15.57 

1812  

16.11 

to 

1868  

15.59 

1813  

16.25 

1840  

....  15.62 

1869  

15.60 

1814  

15.04 

1841  

....  15.70 

1870  

15.57 

1815  

15.26 

1842  

....  15.87 

1871  

15.57 

1816  

15.28 

1843  

....  15.93 

1872  

15.65 

1817  

15.11 

1844  

....  15.85 

1873  

15.92 

1818  

15.35 

1845  

....  15.92 

1874  

16.17 

1819  

15.33 

1846  

15.90 

1875  

16.62 

1820  

15.62 

1847  

....  15.80 

1876  

17.77 

1821  

15.95 

1848  

....  15.85 

1877  

17.22 

1822  

15.80 

1849  

....  15.78 

1878  

17.92 

1823  

15.84 

1850  

....  15.70 

1879  

18.39 

1824  

15.82 

1851  

15.46 

1880  

18.04 

1825  

15.70 

1852  

15.59 

1881  

18.24 

1826  

15.76 

1853  

15.33 

1882  

18.25 

1827  

15.74 

1854  

15.33 

1883  

18.65 

1828 

1855  

15.38 

1884  

18.63 

to 

1856  

15.38 

1885  

19.39 

1829  

15.78 

1857  

....  15.27 

1886  

20.73 

i  Compiled  by  the  Director  of  the  United  States  Mint. 


60 

Year. 

MONEY  AND  BANKING 

Ratio.    Year.                       Ratio.    Year. 

Ratio. 

1887  

21.13 

1894  

32.56 

1901  

34.68 

1888  

21.99 

1895  

31.60 

1902  

39.15 

1889   

22.09 

1896  

30.59 

1903  

.  38  10 

1890  

19.17 

1897  

34.20 

1904  

35.70 

1891  

20.92 

1898  

35.03 

1905  

33.87 

1892     .      . 

23.72 

1899  

34.36 

1906  

.     30  54 

1893  

26.49 

1900  

33.33 

69.  Change  of  ratio  to  16:1. — The  monetary  system 
was,  therefore,  on  a  strict  silver  basis  during  this  period, 
all  the  gold  having  been  exported,  hoarded  or  diverted 
into  the  arts.     In  1834,  Congress,  in  an  attempt  to  rem- 
edy the  condition,  reduced  the  weight  of  the  gold  dollar 
from  24.75  grains  to  23.2  grains  of  pure  gold.     This 
represented  a  ratio  of  approximately  16  to  1.     The  com- 
mercial ratio  in  1834  was  15.73  to  1,  nor  did  it  reach  the 
mint  ratio  until  forty  years  later.     It  was  probably  as 
nearly  correct,  however,  as  any  arbitrary  ratio  which 
could  have  been  settled  upon. 

It  will  be  seen,  in  fact,  in  a  subsequent  chapter  on 
"Bimetallism"  how  ineffectual  any  attempt  must  be  to 
establish  by  enactment  in  a  single  country  a  ratio  of 
value  between  two  such  commodities  as  gold  and  silver, 
which  have  universal  utility  and  a  world  market.  Just 
as  gold  was  driven  out  of  circulation  when  the  ratio  was 
too  low,  so  after  1834  silver  was  driven  out  because  it 
was  too  high.  Silver  was  worth  more  as  bullion  than 
it  was  at  the  mint,  and  the  country  soon  found  itself  on 
a  gold  basis.  In  1834  the  ratio  was  changed  to  15.98  to 
1,  but  the  difference  was  so  slight  that  it  had  little  ef- 
fect. 

70.  Legal  tender  acts  created    a  paper  standard. — 
Gold  continued  to  be  the  standard  until  the  legal  tender 
acts  of  1862-1863.     The  first  of  these  acts,  passed  in 
February,  1862,  authorized  the  issue  of  $150,000,000  of 
non-interest  bearing  United  States  notes,  payable  to 


EVOLUTION  OF  THE  STANDARD  OF  VALUE     61 

bearer.  These  notes  were  to  be  receivable  for  all  dues  to 
the  Government  and  to  be  legal  tender  for  all  debts, 
public  and  private,  within  the  United  States.  They 
were,  furthermore,  exchangeable  for  the  6  per  cent  twen- 
ty-year bonds  of  the  United  States  at  the  option  of  the 
holder. 

The  first  bill  was  followed  six  months  later  by  a  second 
measure  authorizing  $150,000,000  more  notes,  and  in 
January,  1863,  the  total  was  increased  to  $400,000,000. 
Thus  there  was  injected  into  the  circulating  medium  of 
the  country  $400,000,000  of  promissory  notes,  the  early 
redemption  of  which  at  least  depended  on  the  success  of 
the  Federal  army  in  the  field  and  the  reestablishment  of 
peace  and  order.  In  accordance  with  Gresham's  Law, 
gold  began  to  disappear  from  circulation  after  the  first 
bill  was  passed,  and  prices  were  soon  expressed  entirely 
in  terms  of  the  new  standard.  The  situation  was  further 
complicated  in  July,  1863,  by  the  repeal  of  the  provision 
for  the  exchange  of  the  notes  into  United  States  bonds, 
and  before  the  end  of  1864  gold  was  quoted  at  280  in 
the  New  York  market.  In  other  words,  the  "green- 
backs" were  worth  but  35  cents  on  the  dollar.  It  is 
obvious  that  the  country  was  no  longer  on  a  gold  basis. 
The  unit  of  value  was  now  the  Government's  promise  to 
pay  $1  in  gold,  a  unit  which  fluctuated  with  the  fortunes 
of  war. 

71.  Single  gold  standard  after  1879. — This  condition 
lasted  long  after  the  conclusion  of  the  war,  but  naturally 
as  it  became  evident  that  the  nation  was  to  endure  and 
the  Government  finances  improved,  the  divergence  be- 
tween gold  and  the  paper  standard  gradually  decreased 
until  it  was  completely  destroyed  when  in  January,  1879, 
the  treasury  offered  to  redeem  its  legal  tender  notes, 
In  1873  an  act  was  passed  which  made  gold  the  sole  le- 


62  \        MONEY  AND  BANKING 

gal  standard.  This  act  accomplished  the  demonetiza- 
tion of  silver  and  was  vigorously  attacked  by  the  friends 
of  that  metal. 

In  1878  the  treasury  was  authorized  to  purchase  sil- 
ver bullion  for  the  purpose  of  coining  it  and  in  1890 
the  Sherman  Act  authorized  the  purchase  of  silver  by 
the  issuing  of  legal  tender  notes.  Neither  case,  how- 
ever, represented  a  retreat  from  the  gold  standard  be- 
cause neither  provided  for  the  free  coinage  of  silver. 
In  spite  of  these  efforts  to  remonetize  silver  and  in  spite 
of  the  even  greater  effort  of  the  Silver  Party  to  elect 
Mr.  Bryan  to  the  Presidency  in  1896  on  a  double  stand- 
ard platform,  gold  has  remained  the  single  legal  stand- 
ard since  the  Act  of  1873  and  the  actual  standard  since 
the  redemption  of  specie  payments  in  1878. 

72.  Act  of  1900. — In  1900  an  act  was  passed  au- 
thorizing the  secretary  of  the  treasury  to  maintain  all 
forms  of  money  issued  or  coined  by  the  United  States 
at  a  parity  of  value  with  the  gold  standard.     How  this 
was  to  be  done,  however,  the  act  did  not  provide.     In- 
asmuch as  this  binds  the  Government  to  receive  both 
silver  and  greenbacks  at  par  with  gold  in  payment  of 
dues  to  itself,  it  indirectly  provides  for  their  redemption. 
Although  the  act  was  a  specific  acknowledgment  on  the 
part  of  the  Government  of  the  intention  to  maintain  this 
parity  of  value,  it  is  to  be  regretted  that  some  means  of 
doing  so  in  case  of  stress  and  decreased  gold  reserves 
was  not  provided. 

73.  Summary. — To   sum  up   the   evolution   of  the 
standard  in  the  United  States:  From  1792  until  1873 
the  legal  standard  was  a  double  one,  gold  and  silver. 
The    actual    standard,    however,    during    this    period 
changed  considerably.     From  1792  until  1834  it  was 
silver;  from  1834  until  1862  it  was  gold.     Then  came 


EVOLUTION  OF  THE  STANDAKD  OF  VALUE     63 

the  legal  tender  acts,  and  greenbacks  became  the  actual 
standard,  to  continue  until  1879.  In  1873  gold  was 
made  the  single  legal  standard;  and  from  the  resump- 
tion of  specie  payment  in  1879  it  has  been  the  actual 
standard  as  well. 


CHAPTER  VI 

STANDARD  OF  DEFERRED  PAYMENTS 

74.  Defects  of  gold. — The  next  function  of  money 
to  be  considered  is  its  use  as  a  standard  of  deferred  pay- 
ments. Obviously  this  differs  from  its  function  as  a 
standard  of  value  only  because  it  introduces  the  time 
element. 

For  this  purpose,  also,  gold  is  a  defective  standard, 
but  it  is  by  far  the  best  that  is  known.  Gold  is  durable. 
Once  mined,  it  is  added  to  the  productions  of  the  past, 
to  remain  always  a  part  of  the  world's  supply.  For 
this  reason  the  amount  mined  in  any  one  year  cannot 
bear  large  enough  proportion  to  the  total  amount  in 
existence  to  cause  great  changes  in  its  value.  Even  with 
an  annual  production  of  $400,000,000  the  amount  in 
existence  is  so  large  that  its  value  is  much  more  stable 
than  anything  else  which  could  be  used  for  the  pur- 
pose. 

Although  the  same  was  formerly  true  of  silver,  its 
production  has  so  greatly  increased  during  the  last 
thirty  years  that  a  single  silver  standard  of  deferred 
payments  would  be  very  unsatisfactory.  In  1876  and 
1890  to  1894  it  fell  50  per  cent.  Changes  as  violent  as 
this  would  not  have  taken  place  had  not  silver  been  de- 
monetized in  the  United  States  and  had  not  the  nations 
of  Europe  also  discarded  it  during  the  last  half  century. 
It  is  evident,  however,  that  these  fluctuations  unfit  silver 
to  act  as  a  standard  of  deferred  payments. 

We  have  already  seen  the  impracticability  of  the 

64 


STANDARD  OF  DEFERRED  PAYMENTS         65 

double  standard,  but  shall  reserve  that  subject  for  more 
careful  consideration  in  a  subsequent  chapter.  In  the 
absence  of  a  better,  we  are  therefore  forced  to  the  con- 
clusion that  gold  is  the  best  standard  for  deferred  pay- 
ments. 

75.  Definition  of  deferred  payments. — Deferred  pay- 
ments are  usually  the  result  of  contracts.  When  we 
stop  to  consider  that  contracts  play  a  part  in  nearly  all 
business  transactions,  the  importance  of  the  subject  is 
appreciated.  Our  investments,  bank  deposits,  notes, 
currency,  in  fact,  a  large  proportion  of  our  wealth  con- 
sists of  contracts.  If  economic  prosperity  is  to  con- 
tinue, these  contracts  must  be  enforced.  To  this  end 
the  Constitution  of  the  United  States  declares  that  "no 
state  shall  pass  any  law  impairing  the  obligation  of  con- 
tracts." 

Although  the  provision  prevents  the  direct  impair- 
ment of  contracts,  the  same  end  may  be  accomplished 
indirectly  by  unwise  monetary  laws.  Anything,  in  fact, 
that  causes  great  changes  in  prices  will  alter  the  effect 
of  contracts.  Practically  all  contracts  are  payable  in 
terms  of  dollars,  and  some  of  them  run  for  long  periods. 
In  order  to  secure  perfect  justice  between  debtors  and 
creditors  it  is  necessary  that  the  dollar  should  mean  the 
same  at  the  maturity  as  at  the  beginning  of  the  con- 
tract. 

Speaking  accurately,  this  is  impossible,  for  even  when 
the  contract  is  specifically  made  payable  in  gold,  the 
purchasing  power  of  that  gold  after  a  period  of  years 
may  have  changed  considerably.  Contracts  payable  in 
gold,  however,  have  always  been  the  most  highly  re- 
garded, because  no  matter  how  distant  the  date  of  ma- 
turity it  is  generally  felt  that  the  value  of  gold  will 
approximate  its  present  value.  The  risk  that  it  will  be 

VII--5 


66  MONEY  AND  BANKING 

greater  or  less  is  only  the  ordinary  business  risk  which 
every  business  man  must  take  and  for  which  he  must 
make  allowance  in  his  calculations. 

A  great  many  contracts,  however,  are  payable  in  terms 
of  "dollars,"  without  specifying  the  kind  of  dollar  that 
is  meant.  While  the  statutes  define  a  dollar  as  23.22 
grains  of  pure  gold,  yet  debts  may  be  legally  paid  by 
other  forms  of  dollars.  The  law  makes  certain  forms 
of  currency  legal  tender  in  payment  of  debts.  The  sil- 
ver dollar  and  the  treasury  notes  are  full  legal  tender. 
Greenbacks  are  full  legal  tender.  National  bank  notes 
are  legal  tender  in  payment  of  any  debt  to  a  national 
bank  and  are  receivable  by  the  Government  for  all  dues 
except  duties  or  imports.  Subsidiary  silver  is  legal  ten- 
der, but  for  convenience  sake  only  to  certain  maximum 
amounts. 

76.  Effect  of  legal  tender  laws. — So  long  as  all  the 
forms  of  currency  are  interchangeable  and  of  the  same 
value,  legal  tender  laws  have  no  particular  significance, 
but  if  some  form  of  currency  is  depreciated  it  is  obvious 
that  no  creditor  will  care  to  receive  it  and  every  debtor 
will  want  to  pay  in  that  form  of  currency.     For  in- 
stance, when  the  greenbacks  depreciated  to  35  cents  on 
the  dollar  in  1864,  they  were  still  legal  tender  unless 
otherwise  specified  in  the  contract.     No  debtor  would 
think  of  paying  his  debt  in  gold  dollars  because  with 
35  per  cent  of  that  amount  of  gold  he  could  buy  de- 
preciated greenbacks  that  would  fully  satisfy  the  debt. 

77.  Constitutionality  of  Legal  Tender  Acts. — The 
right  of  the  Government  to  pass  the  Legal  Tender  Acts 
was  in  fact  declared  unconstitutional  by  the  Supreme 
Court  because  it  violated  the  clause  of  the  Constitution 
which  forbade  the  impairment  of  the  validity  of  con- 
tracts.    This  decision  was  reversed,  however,  by  a  sub- 


STANDARD  OF  DEFERRED  PAYMENTS        '67 

sequent  Supreme  Court  which  declared  the  statute  con- 
stitutional under  the  authority  given  to  Congress  to 
provide  means  for  carrying  on  war. 

Waiving  the  question  of  constitutionality  of  legal  ten- 
der acts,  it  may  be  well  to  consider  whether  under  any 
circumstances  there  is  any  advantage  to  be  gained  by 
adding  the  legal  tender  feature  to  the  various  forms  of 
circulating  media.  Does  the  medium  become  more  val- 
uable because  of  the  legal  tender  stamp?  Obviously, 
if  a  country  adopts  the  gold  standard,  making  gold 
legal  tender,  it  increases  the  value  of  gold  somewhat 
because  it  increases  the  demand  for  it.  But  this  is  be- 
cause gold  is  needed  as  a  medium  of  exchange.  The 
legal  tender  feature  adds  nothing  because  it  will  circu- 
late at  its  actual  metal  value.  When  a  country  attaches 
the  legal  tender  stamp  to  two  metals  we  have  already 
seen  that  the  cheaper  will  drive  out  the  dearer  and  that 
the  cheaper  metal  will  also  circulate  at  its  metal  value. 

In  the  case  of  the  greenbacks  the  legal  tender  feature 
added  nothing  to  their  circulating  power,  as  is  shown  by 
the  fact  that  they  fluctuated  in  value  as  the  time  of 
their  redemption  seemed  early  or  remote.  The  legal 
tender  feature,  is,  therefore,  of  value  solely  to  the 
debtors,  who  can  take  advantage  of  laxity  of  their  con- 
tracts to  pay  their  debts  in  depreciated  currency  when 
they  should  pay  in  the  standard  metal.  It  adds  little, 
therefore,  to  the  circulating  power  of  the  medium  to 
which  it  is  attached,  and  what  little  it  does  add  inures 
to  the  advantage  of  a  single  class. 

The  whole  free  silver  agitation  was  an  attempt  to 
change  the  standard  because  it  was  believed  that  in  re- 
gard to  its  use  as  a  standard  of  deferred  payments  gold 
was  defective.  It  is  apparent  that  it  is  to  the  advantage 
of  the  debtor  class  to  have  a  standard  which  is  con- 


68  MONEY  AND  BANKING 

stantly  depreciating  in  comparison  with  goods ;  in  other 
words,  that  goods  should  be  apparently  rising  in  value. 
78.  Debtor  class  injured  by  an  appreciating  standard. 
— From  1860  to  1896  there  was  a  large  debtor  class  in 
the  country  composed  of  farmers  who  had  gone  West 
and  purchased  land  on  mortgage.  These  farmers 
bought  the  land  agreeing  to  pay  a  certain  price  in  the 
future  and  a  certain  rate  of  interest  each  year.  This 
price  and  interest  rate  were  based  upon  the  value  of 
crops,  particularly  wheat,  which  in  the  early  70's  was 
worth  as  high  as  $2  per  bushel.  The  price  of  wheat 
gradually  declined  until  in  1894  it  was  worth  less  than 
50  cents  per  bushel.  The  farmers  found  themselves 
unable  to  meet  the  interest  payments,  much  less  to  pro- 
vide for  the  paying  off  of  the  principal.  They  were 
told  that  this  condition  was  due  to  the  appreciation  in 
the  value  of  gold  following  the  demonetization  of  silver 
in  1873.  They  were  also  told  that  if  silver  could  be  re- 
monetized,  that  is,  made  the  standard  of  value  along  with 
gold,  that  the  quantity  of  standard  money  would  be 
doubled,  that  the  value  of  standard  money  would  be 
reduced  one-half  and  the  value  of  everything  else 
doubled.  This  debtor  class  composed  the  backbone  of 
the  Silver  party  in  1896.  Fortunately  before  another 
election  was  held  the  question  had  been  settled  to  the 
satisfaction  of  everybody  by  the  unexpected  increase  in 
the  production  of  gold. 


CHAPTER  VII 

SUPPLY  AND  DEMAND  IN  RELATION  TO  MONEY 

79.  Price. — There  is  a  distinction  between  the  use  of 
the  words  "value"  and  "price"  which  it  is  well  to  under- 
stand clearly.  Value  is  the  expression  of  a  ratio  of 
importance  between  two  commodities.  If,  for  example, 
one  wishes  to  express  his  estimate  of  the  worth  of  a  pair 
of  shoes  it  is  necessary  to  make  a  comparison  with  some 
other  commodity.  Thus  the  value  of  a  pair  of  shoes 
may  be  expressed  as  equal  to  two  hats,  or  the  ratio  ex- 
pressed is  one  to  two. 

Price  is  a  ratio  expressing  a  comparison  of  value,  but 
one  of  the  terms  of  the  ratio  is  money.  The  use  of  a 
standard  of  value  which  is  familiar  to  everybody 
enormously  simplifies  the  expression  of  values.  In  order 
that  price  may  have  a  clear  and  definite  meaning  it  is 
necessary  that  the  money  standard  fluctuate  as  little  as 
possible.  If,  however,  there  is  a  change  in  the  value  of 
the  standard,  it  alters  the  real  meaning  of  every  quoted 

price. 
i 

That  the  prices  of  goods  depend  quite  as  much  upon  the  value 

of  money  as  upon  the  value  of  the  goods  themselves,  is  a  truth 
that  the  reader  must  fully  grasp.  It  may  be  a  little  puzzling  at 
first,  for  it  is  natural  to  think  of  money  as  a  fixed  and  stable 
thing,  with  respect  to  which  other  things  fluctuate.  To  many 
men  the  idea  that  money  changes  in  value  is  as  novel  when  first 
presented  as  the  notion  that  the  ocean  changes  its  level.  The 
reason  for  this  misapprehension  with  regard  to  the  value  of 
money  lies  in  the  fact  that  men  think  of  price  as  being  identical 

69 


70  MONEY  AND  BANKING 

with  value,  and  since  the  "price"  of  gold  (and  of  silver  in  a 
country  where  it  is  freely  coined  into  money)  never  changes,  it 
is  assumed  that  the  value  of  gold  is  unchanging.  The  common 
belief  in  the  stability  of  money  is  analogous  to  the  illusion  exist- 
ing among  primitive  peoples  with  regard  to  the  solar  system. 
They  think  the  earth  is  stationary.  It  is  their  view  point,  and 
all  changes  on  the  screen  of  the  firmament  seem  to  them  to  reflect 
changes  in  the  heavens,  not  in  the  position  of  the  earth.  The 
analogy,  like  all  analogies,  is  imperfect,  but  it  is  suggestive. 
The  fact  that  changes  in  price  reflect  changes  in  the  value  of 
money  as  well  as  changes  in  the  values  of  goods  is  very  im- 
portant.1 

Every  man  of  business  who  buys  and  sells  property 
has  a  deep  interest  in  the  fluctuation  of  prices.  Most 
of  them  are  thoroughly  familiar  with  the  causes  which 
produce  fluctuations  so  far  as  they  are  caused  by  in- 
fluences affecting  commodities.  Only  those  who  have 
made  a  special  study  of  the  subject  comprehend  the 
influence  of  the  fluctuations  of  prices  on  the  conditions 
affecting  the  money  side  of  the  ratio. 

80.  Prices  depend  upon  the  money  market. — A  long 
continued  and  steady  rise  of  prices  may  take  place  in 
the  face  of  conditions  of  supply  and  demand  for  com- 
modities which  would  seem  to  warrant  quite  the  opposite 
tendency.  On  the  other  hand  there  may  be  a  very  great 
fall  of  prices  notwithstanding  the  fact  that  conditions 
of  supply  and  demand  for  commodities  justify  higher 
prices.  The  explanation  of  this  must  be  sought  for  in 
the  money  market. 

The  value  of  money  as  of  everything  else  is  the  result 
of  an  equilibrium  between  supply  and  demand.  How 
these  forces  produce  the  result  so  far  as  goods  are  con- 
cerned we  have  already  seen  in  the  chapter  on  value. 

i  Johnson,  "  Money  and  Currency,"  p.  31. 


SUPPLY  AND  DEMAND  71 

The  value  of  money  is  determined  in  the  same  way,  but 
the  conditions  of  supply  and  demand  are  so  complex  as 
to  require  a  special  study  of  them. 

81.  Utility  of  money. — Money  is  utility  in  the  form 
of  immediate  universal  acceptability.     Its  utility  lies  in 
its  exchangeability  in  the  same  manner  that  nutrition  is 
the  basis  of  the  utility  of  food.     Money  is  demanded 
because  of  the  need  felt  by  men  for  this  particular  kind 
of  utility.     The  name  which  we  give  to  this  conscious 
need  of  men  for  anything  is  "desire."     The  failure  to 
distinguish  between  desire  and  demand  has  been  a  fer- 
tile source  of  error  in  economic  thought.     Some  of  the 
most  eminent  of  earlier  economists,  observing  that  the 
desire  for  money  was  universal  among  men,  concluded 
that  therefore  the  demand  for  money  was  unlimited. 
If  that  were  the  case  it  would  be  absolutely  impossible 
to  analyze  the  forces  determining  the  value  of  money. 
It  would  be  the  same  as  the  attempt  to  find  the  point  of 
equilibrium  which  would  be  the  result  of  several  phys- 
ical forces  if  one  of  these  forces  was  infinite. 

82.  Distinction   between   desire  and   demand. — De- 
mand as  used  in  an  economic  sense  is  "desire"  backed 
up  by  the  willingness  to  sacrifice  or  give  up  something 
in  exchange.     The  only  method  we  have  of  measuring 
demand  is  by  the  amount  of  value  which  will  be  sacri- 
ficed in  order  to  obtain  the  object  of  the  demand.     The 
demand  for  money  can  be  measured  only  by  the  amount 
of  other  valuable  property  which  will  be  given  in  ex- 
change for  it. 

Under  the  foregoing  definition  the  demand  for 
money  is  limited,  definite,  and  liable  to  fluctuate  from 
time  to  time.  If  a  man  offers  $300  for  a  horse  it  is 
evident  that  his  desire  for  the  horse  is  greater  than  his 
desire  for  $300.  The  seller  of  the  horse  would  desire 


72  MONEY  AND  BANKING 

the  money  more  than  the  horse.  The  question  of  the 
demand  for  money  may  be  reduced  to  this:  Why  do 
people  desire  money? 

83.  Three  varieties  of  money. — In  the  first  place  it 
is  necessary  to  distinguish  between  different  varieties 
of  money.     There  are  three  kinds  of  money:  standard 
money,  fiat  money,  and  credit  money.     The  demand  for 
these   different   varieties   is   not   uniform   and   under 
various  circumstances  shifts  from  one  to  the  other. 

Standard  money  or  commodity  money  is  some  ma- 
terial which  because  of  its  proprietary  qualifications  has 
been  adopted  by  any  particular  group  of  people  as  a 
common  medium  of  exchange,  as  explained  in  the  pre- 
ceding chapter  on  the  Evolution  of  Money.  Its  supply 
is  regulated  automatically,  being  dependent  on  the  cost 
of  production. 

Fiat  money  is  the  medium  of  exchange,  the  value  of 
which  has  no  relation  to  the  worth  of  the  material  com- 
posing it.  Its  value  is  derived  from  its  utility  as  a 
medium  of  exchange.  Its  supply  is  regulated  artifi- 
cially by  legislative  enactment. 

Credit  money  is  simply  a  promise  to  pay  the  money 
which  is  in  such  form  that  it  can  be  used  as  a  medium 
of  exchange.  A  promise  to  pay  money  by  some  re- 
sponsible party  may  be  just  as  valuable  or  even  more 
valuable  than  the  money  itself  if  it  serves  the  purpose 
of  money. 

84.  Fiat  v.  credit  money. — The  distinction  between 
fiat  and  credit  money  is  an  exceedingly  difficult  one  to 
make  in  practice.     In  practically  every  case  of  fiat 
money,  there  is  a  promise  either  expressed  or  implied 
to  pay  the  amount  in  standard  money  at  some  indefinite 
time;  if  not  a  promise  at  least  an  expectation  or  ac- 
ceptance of  the  money  in  payment  of  taxes  and  other 


SUPPLY  AND  DEMAND  73 

sums  due  the  government  issuing  it.  It  would  be  diffi- 
cult indeed  to  imagine  fiat  money  which  the  government 
itself  would  not  accept  in  payment  or  which  it  never 
expected  to  redeem. 

85.  Demand   for    money    analyzed. — The    demand 
for  money  may  he  studied  by  analyzing  the  various 
forms  of  desire  for  money. 

1.  People  desire  money  for  the  purpose  of  exchang- 
ing it  for  other  commodities  within  a  short  time. 

2.  People  desire  money  that  they  may  have  a  store 
of  value  which  for  the  time  being  is  preferable  to  goods 
which  have  a   (1)   direct  utility,  i.  e.,  those  affording 
satisfaction  by  their  use,  or  (2)  indirect  utility,  i.  e.,  the 
use  of  which  produces  more  value,  as  in  the  case  of  all 
capital  goods.     In  some  rare  instances  the  money  is 
esteemed  for  itself  alone  without  reference  to  its  ex- 
changeability, as  in  the  case  of  a  miser's  hoard. 

3.  People  desire  money  as  a  reserve  basis  for  credit. 
These  three  classifications  cover  all  the  desires  for 

money  and  changes  in  the  intensity  of  these  desires  have 
their  effect  on  the  value  of  money. 

86.  Rapidity  of  circulation. — The  extent  of  the  de- 
sire for  money  for  the  purpose  of  exchanging  it  for 
goods  within  a  short  time  determines  the  rapidity  of 
circulation.     The  measure  of  the  rapidity  of  circula- 
tion of  money  is  the  form  of  exchanges,  which  is  de- 
pendent upon  four  factors;     1.  The  number  of  popu- 
lation.    2.  The  production  and  distribution  of  wealth 
per  capita.     3.  The  extent  to  which  division  of  labor 
or  specialization  of  employment  prevails.     4.  The  ex- 
tent of  the  integration  of  industry. 

87.  Effect  of  population. — Other  things  being  equal, 
doubling  the  population  would  double  the  demand  for  a 
circulating  medium.     There  would  be  twice  as  manjr 


74  MONEY  AND  BANKING 

producers  and  twice  as  many  consumers.  Therefore  it 
would  require  just  twice  as  much  money  to  circulate 
the  goods  required  for  their  consumption.  In  a  country 
of  increasing  population,  therefore,  there  must  be  a  pro- 
portionate increase  in  the  quantity  of  money.  Other- 
wise the  increased  demand  upon  the  supply  will  tend  to 
raise  the  value  of  money,  bringing  with  it  falling  prices. 

Even  with  a  stationary  population,  advancing  civiliza- 
tion inevitably  brings  an  increase  in  the  production  and 
consumption  of  wealth,  the  circulation  of  which  puts  a 
greater  demand  upon  money. 

88.  Effect  of  division  of  labor. — Along  with  the  in- 
creased production  of  goods  per  capita  comes  the  in- 
creasing division  of  labor.  In  fact,  the  greater  special- 
ization of  employment  is  one  of  the  most  potent  causes 
of  increase  of  wealth.  In  primitive  communities  where 
the  producer  consumes  a  large  part  of  his  product  there 
is  little  demand  for  money,  not  at  all  in  proportion  to 
the  productivity  of  each  man.  Whenever  men  begin  to 
confine  themselves  to  fewer  occupations,  especially  if 
at  the  same  time  the  variety  of  their  wants  increases, 
they  are  under  the  necessity  of  obtaining  their  supplies 
by  means  of  exchange,  and  this  exchange  requires  a 
medium.  Hence  it  is  that  division  of  labor  requires 
an  increase  in  the  supply  of  money  out  of  proportion  to 
the  increase  of  product  per  capita. 

Opposed  to  this  tendency  and  lessening  somewhat  the 
demand  for  money  is  the  integration  of  industry. 
When  a  number  of  individuals  or  corporations  engaged 
in  the  various  processes  of  the  manufacture  of  a  line 
of  goods  combine  so  that  the  several  processes  are  con- 
ducted under  one  ownership,  the  necessity  for  a  large 
number  of  exchanges  is  eliminated.  It  may  even  go 
so  far  that  no  exchange  takes  place  after  the  raw  ma- 


SUPPLY  AND  DEMAND  75 

terials  are  purchased  until  the  finished  product  is  sold 
to  the  consumer. 

89.  Special  demand  for  gold. — Under  present  condi- 
tions in  this  country  all  the  forms  of  money  described 
above   perform   the    function   of   exchanging    goods 
equally  well,  with  possibly  a  slight  advantage  on  the 
part  of  paper  credit  money  on  the  score  of  convenience. 
In  our  trade  with  foreign  countries,  however,  if  there 
is  a  balance  of  imports  over  exports  one  way  or  the 
other  which  must  be  settled  with  money,  there  is  only  one 
form  which  will  serve  the  purpose,  i.  e.,  gold.     Increase 
of  demand  from  this  source,  may  under  some  circum- 
stances tend  to  enhance  the  value  of  gold,  independently 
of  the  value  of  the  other  forms.     This  phenomenon  ap- 
pears in  the  form  of  a  premium  on  gold,  of  which  we 
shall  speak  later. 

90.  Payment   of   contracts. — Another   demand   for 
money  is  in  the  payment  of  contracts.     Unless  there 
is  a  disparity  in  the  value  of  the  different  forms  of 
money  the  demand  for  money  to  liquidate  contracts  is 
likely  to  fall  on  all  equally.     Sometimes  the  demand 
for  money  for  this  purpose  is  artificially  interfered  with 
by  the  Government,  as  in  the  case  of  legal  tender  laws 
which  force  the  creditor  against  his  interest  and  inclina- 
tion to  accept  certain  forms  of  money  such  as  the  green- 
backs.    The  tendency  in  such  a  case  as  this  is  to  shift 
the  demand  from  gold  to  credit  or  fiat  money,  and  thus 
eliminate  the  disparity. 

91.  Store  of  value. — The  demand  for  money  as  a 
store  for  value  without  the  intention  of  exchanging  it 
for  goods  within  a  short  time  depends  largely  upon  the 
habits  of  the  people  and  the  stability  of  the  Govern- 
ment.    Money  as  a  store  for  value  is  at  a  disadvantage 
when  compared  with  productive  property,  and  under 


76  MONEY  AND  BANKING 

normal  conditions  prudent  people  will  regard  stores  of 
money  as  very  unprofitable  investments. 

92.  Insecurity  of  property  and  contracts. — Under 
certain  conditions,  however,  it  may  be  advantageous  to 
hold  property  in  the  form  of  money.     In  countries  such 
as  Turkey  where  the  government  is  unable  to  protect 
property  and  where  it  is  liable  to  heavy  taxes  or  even 
to  confiscation,  the  profit  derived  from  the  investment 
of  money  in  productive  enterprises,  although  very  great, 
may  be  so  risky  and  uncertain  as  to  be  unattractive.     In 
such  a  country  those  citizens  who  are  least  protected  by 
the  government  are  inclined  to  safeguard  their  future 
welfare  by  hiding  away  their  wealth  in  the  form  of 
money.     The  satisfaction  they  derive  from  the  con- 
sciousness of  being  protected  in  their  old  age  and  being 
relieved  from  the  fear  of  loss  of  property  more  than 
compensates  them  for  the  loss  of  even  a  large  income. 
According  to  the  extent  to  which  property  is  protected 
and  contracts  are  enforced  as  well  as  the  amount  of  in- 
come that  can  be  derived  from  investments,  will  the 
people  of  any  country  be  disinclined  to  hoard  accumula- 
tions of  money. 

93.  Special  demand  for  money  as  a  store  of  value. — 
In  every  country,  however,  no  matter  how  stable  the 
conditions,  there  are  times  when  money  is  more  highly 
esteemed  than  any  other  form  of  property.     When 
there  is  a  prospect  of  falling  prices  of  commodities  it  is 
advantageous  to  exchange  property  for  money  because 
the  value  of  money  rises  in  exact  proportion  as  com- 
modities fall.     At  the  end  of  periods  of  prosperity  when 
prices  of  all  property  have  been  inflated  and  there  is  a 
prospect  that  the  culmination  of  the  boom  is  approach- 
ing, this  state  of  affairs  is  likely  to  be  perceived  sud- 
denly by  a  large  number  of  people,  who  at  once  become 


SUPPLY  AND  DEMAND  77 

eager  to  exchange  their  property  into  cash;  the  desire 
of  a  large  number  to  sell  at  the  same  time  of  course 
brings  a  sudden  fall  in  prices  which  we  call  a  panic. 

The  converse  of  this  takes  place  at  the  beginning  of 
a  boom  period,  when  people  realize  that  prices  are  too 
low  and  that  purchases  will  yield  large  speculative 
profits.  There  is  a  rush  to  buy,  that  is  to  say,  a  desire 
to  convert  money  which  is  about  to  fall  in  value  into 
forms  of  property  which  will  increase  in  value. 

The  desire  to  convert  property  into  money  is  only  one 
of  the  causes  and  symptoms  of  a  panic.  In  a  later 
chapter  on  credits  a  fuller  discussion  of  this  will  be 
given.  The  liquidation  of  credits,  either  forced  or  vol- 
untary, at  the  beginning  of  a  panic  accounts  for  a  large 
part  of  the  sudden  demand  for  money  and  is  the  prox- 
imate cause  for  the  liquidation  of  property. 

94.  Hoarding. — When  the  storing  away  of  money 
becomes  excessive  we  call  it  hoarding.     It  would  be  ex- 
ceedingly difficult  to  attempt  to  draw  the  line  where 
hoarding  begins.     The  amount  of  money  which  prudent 
people  will  have  ready  for  necessary  purchases  and  the 
payment  of  debts  will  vary  widely  under  different  cir- 
cumstances.    In  the  panic  of  1897  the  country  banks 
all  over  the  country  withdrew  their  deposits  from  the 
New  York  banks  in  order  to  be  amply  protected  in  case 
of  large  sudden  demands  from  their  depositors.     A 
great  many  banks  carried  this  practice  to  an  unreason- 
able extent  and  filled  their  vaults  with  money  for  which 
they  had  no  use  and  for  which  there  was  likely  to  be  no 
use  except  in  the  case  of  most  extraordinary  disaster. 
Such  storing  away  of  money  we  can  properly  call  hoard- 
ing. 

95.  Decline  of  hoarding. — Steady  progress  in  the 
direction  of  improving  the  financial  and  banking  sys- 


78  MONEY  AND  BANKING 

terns  and  the  widespread  education  of  the  people  in  the 
advantages  of  dealing  with  banks  has  diminished  hoard- 
ing in  this  country  until  under  normal  conditions  in  the 
present  era  it  is  practically  limited  to  persons  in  rural 
districts  and  to  a  few  eccentric  individuals  who  are  will- 
ing to  run  the  risk  of  robbery  in  order  to  enjoy  the 
satisfaction  of  an  occasional  view  of  a  pile  of  yellow 
coins  or  of  green  paper. 

It  is  extremely  easy,  however,  to  frighten  people  out 
of  their  banking  habits  and  cause  them  to  revert  to  the 
more  primitive  methods.  The  failure  of  a  prominent 
bank  or  the  exposure  of  unsavory  methods  in  high 
finance  will  induce  a  great  many  timid  persons  to  with- 
draw their  deposits  from  banks  and  stow  away  the 
money  in  safety  deposit  vaults  or  in  some  hiding  place 
in  their  homes. 

96.  Bank  reserves  not  hoards. — The  enormous  sums 
of  money  stored  in  the  vaults  of  banking  institutions  are 
not  hoards  in  the  sense  in  which  we  are  using  the  term. 
These  dollars  are  really  supporting  the  credit  of  the 
country,  which  as  a  substitute  is  doing  the  real  money 
work.     In  fact,  an  idle  dollar  in  the  reserve  backing  up 
credit  is  really  doing  four  or  five  times  as  much  work  as 
its  brother  in  circulation.     The  full  explanation  of  this 
point  is  deferred  to  the  chapters  on  credit. 

97.  Government  hoarding. — While  the  great  sums  of 
money  in  bank  reserves  are  not  hoards  unless  they  should 
be  excessive,  there  are  at  times  huge  amounts  in  the 
Government  treasury  and  sub-treasuries  which  are  really 
hoards.     The  law  requires  that  $150,000,000  in  gold 
shall  be  maintained  in  the  treasury  as  reserve  against 
the  greenbacks  outstanding.     This  sum  is  a  true  re- 
serve and  not  at  all  a  hoard.     Furthermore,  the  gold  and 
silver,  both  coin  and  bullion,  which  are  held  in  the 


79 

treasuries  and  against  which  gold  and  silver  certificates 
are  circulating  are  not  hoards.  The  paper  money  which 
represents  them  is  doing  the  work  by  proxy.  Unlike 
the  bank  reserve,  however,  which  through  its  substitutes 
does  four  or  five  times  the  amount  of  money  work,  the 
gold  and  silver  certificates  do  no  more  than  gold  and 
silver  itself  could  have  done.  The  only  advantage  de- 
rived from  the  system  is  the  greater  convenience  and 
the  saving  of  the  wear  and  tear  on  the  metal. 

Another  part  of  the  money  held  by  the  Government 
represents  a  store  of  cash  ready  for  future  expenditures. 
This  is  the  sum  necessary  to  be  kept  on  hand  in  order 
to  provide  for  purchases  within  a  short  time,  just  as 
individuals  find  it  necessary  to  keep  a  certain  amount  of 
cash  on  hand  for  the  same  purpose. 

Any  amount  of  money  held  in  the  treasury  beyond  the 
sums  mentioned  above  is  a  hoard,  representing  purchas- 
ing power  which  is  withheld  from  circulation  and  for 
the  time  being  absolutely  useless. 

98.  Discrimination  in  demand  for  money. — The  dif- 
ferent forms  of  demand  for  money  which  we  have  out- 
lined above  do  not  apply  at  all  times  equally  to  all  the 
different  varieties  of  money.  There  are  sometimes  cir- 
cumstances when  the  demand  falls  upon  one  kind  alone. 
So  long  as  all  the  different  forms  are  kept  at  parity  the 
demand  for  a  circulating  medium  to  exchange  goods  or 
to  liquidate  debts  is  satisfied  with  either  form.  Then 
sometimes  the  question  of  convenience  plays  a  part,  as  in 
the  case  of  the  silver  dollar  after  the  silver  purchases  in 
the  80's.  These  silver  dollars  refused  to  circulate 
in  the  quantities  desired  because  the  people  had  learned 
to  prefer  paper  on  the  score  of  convenience.  They 
would  refuse  to  take  them  from  the  banks  and  would 
deposit  them  freely;  the  banks  would  turn  them  back 


80  MONEY  AND  BANKING 

into  the  Government  treasury  in  exchange  for  paper 
which  their  depositors  demanded.  The  Government 
even  went  so  far  as  to  pay  express  charges  to  dis- 
tant points  in  order  to  keep  the  silver  dollars  in  circula- 
tion and  finally  the  ingenious  plan  was  hit  upon  of  stor- 
ing away  the  silver  dollars  and  issuing  in  their  stead 
silver  certificates  of  one  and  two  dollar  denominations 
which  were  circulated  in  their  place. 

99.  Seasonal  demand  for  money. — For  90  per  cent  or 
more  of  the  domestic  exchanges  no  money  is  required  at 
all,  bank  credit  in  the  form  of  checks  and  drafts  serving 
the  purpose.     This  relieves  the  money  of  the  country 
of  most  of  the  demand  but  there  are  circumstances  when 
this  bank  credit  fails  to  do  its  work.     During  the  crop 
moving  season  in  the  South  and  West  there  is  a  demand 
for  a  medium  of  exchange  which  cannot  be  supplied  by 
bank  credit.     Every  autumn  there  is  likely  to  be  a  de- 
mand for  about  $150,000,000  of  extra  money  to  finance 
the  crop  moving.     This  sum  must  ordinarily  come  out 
of  the  reserves  of  the  banks,  causing  a  contraction  of 
credit,  after  credit  has  been  expanded  and  giving  rise 
to  dangerous  stringencies  in  the  financial  centers.     This 
special  seasonal  demand  for  cash  and  the  monetary  prob- 
lems which  it  occasions  will  be  the  subject  of  special  dis- 
cussion later  in  this  volume. 

100.  Demand  for  money  in  international  trade. — 
The  exchanging  of  goods  between  this  country  and 
abroad  requires  the  use  of  but  a  minimum  of  money; 
only  the  differences  between  the  exports  and  imports 
are  required  to  be  settled  in  cash.     The  only  possible 
form  of  money  which  can  be  used  in  making  this  inter- 
national settlement  of  trade  balances  is  gold.     Some- 
times the  difference  between  the  imports  and  exports 
is  so  great,  or  there  has  been  so  much  international  bor- 


SUPPLY  AND  DEMAND  81 

rowing  that  the  resulting  movement  of  gold  in  or  out  of 
the  country  is  a  question  of  extreme  importance  because 
of  the  effect  it  has  upon  bank  or  Government  reserves 
and  the  maintenance  of  credit.  It  is  this  demand  for 
gold  to  be  used  in  making  foreign  settlements  that  ac- 
counts for  the  appearance  of  a  premium  on  gold  under 
certain  circumstances.  Whenever  foreign  banks  find 
that  they  cannot  exchange  other  forms  of  money  for 
gold  they  are  driven  to  procure  it  wherever  they  can  by 
offering  a  premium  for  it. 

101.  Premium  on  gold. — Experience  has  shown  that 
the  appearance  of  a  small  premium  on  gold  is  attended 
by  such  serious  disturbances  in  the  credit  situation  of  the 
country  that  such  an  event  is  to  be  avoided  if  possible. 
The  seriousness  of  this  matter  led  President  Cleveland 
in  1894  to  put  out  several  issues  of  bonds  and  to  deal 
with  the  syndicate  of  New  York  banks  in  order  to  pre- 
vent a  premium  on  gold,  or  in  other  words  to  maintain 
a  parity  among  all  forms  of  money  in  the  United  States. 
The  President  did  this  in  the  face  of  popular  disapproval 
by  the  mass  of  citizens  who  did  not  comprehend  the 
necessity  of  these  actions. 

All  forms  of  money  (except  national  bank  notes  in 
national  banks  themselves)  serve  the  purpose  of  bank 
reserves  equally  well,  although  gold  is  preferable  be- 
cause it  assists  the  Government  in  supporting  the  cir- 
culating credit.  It  was  proposed  in  recent  currency 
bills  to  compel  the  banks  to  maintain  their  reserves  in 
gold  in  order  that  there  shall  always  be  a  satisfactory 
basis,  for  the  credit  of  the  country. 

102.  Uncertainty  of  the  demand  for  money. — The 
demand  for  money  is  a  very  uncertain  quantity.     The 
uncertainties  of  its  substitute,  credit,  may  cause  very  sud- 
den and  very  great  changes  in  the  demand  for  money. 


82  MONEY  AND  BANKING 

The  growth  of  population  increases  specialization  of  em- 
ployment and  the  increasing  volume  of  industry  per 
capita  causes  an  increasing  demand  for  a  medium  of 
exchange.  On  the  other  hand,  however,  the  perfection 
of  the  credit  machinery  and  the  extension  of  banking 
facilities  economize  the  use  of  money  and  lessen  the  de- 
mand. The  suddenness  with  which  any  derangement  of 
the  financial  machinery  will  cause  a  shift  of  demand 
from  one  form  of  money  to  another  is  one  of  the  com- 
plexities of  the  subject. 

103.  Supply  of  money. — In  contrast  with  the  insta- 
bility of  the  demand  for  money  the  supply  of  money  is 
so  stable  as  to  give  rise  to  the  problem  of  "elastic  cur- 
rency."    The  only  uncertain  element  in  the  supply  is 
found  in  credit,  which  is  a  substitute  for  money  and 
does  the  same  kind  of  service. 

104.  Varieties    of    United   States   money. — In   the 
United  States  at  the  present  time  there  is  in  circulation, 
first,  the  United  States  notes  or  greenbacks.     The  sup- 
ply of  this  form  of  money  is  absolutely  unchanging, 
amounting  to  $346,000,000. 

Second,  the  gold  and  silver  certificates,  representing 
actual  metal  deposited  in  the  treasuries.  The  supply  of 
these  certificates  varies  with  the  amount  of  gold  and 
silver  deposited  in  Washington  and  the  increase  or  de- 
crease in  their  amount  is  offset  by  a  correspondingly 
opposite  change  in  the  supply  of  metal  money. 

Third,  National  bank  notes  are  somewhat  elastic,  but 
are  so  limited  by  the  amount  of  bonds  which  banks  can 
acquire  to  deposit  as  security  for  them  that  the  supply 
can  be  regarded  as  fairly  stable. 

Fourth,  The  supply  of  silver  coinage  in  the  country 
is  regulated  by  arbitrary  action  of  the  Government. 


SUPPLY  AND  DEMAND  83 

Outside  the  subsidiary  coinage  its  use  is  so  limited  that 
it  cannot  be  regarded  as  an  elastic  element. 

Fifth,  Gold  is  the  only  really  elastic  element  in  our 
country  at  the  present  time.  The  amount  in  the  country 
for  monetary  purposes  at  any  time  is  influenced  by  our 
financial  and  trade  relations  with  foreign  countries.  In 
the  chapter  on  foreign  exchanges  the  causes  of  increase 
or  decrease  in  the  quantity  of  gold  in  the  country  is 
explained  in  all  its  details. 

105.  Supply  of  gold. — The  quantity  of  gold  actually 
produced  in  the  country  has  very  little  effect  upon  the 
supply  in  that  country.     Gold  is  so  easily  transported 
that  it  equally  distributes  itself  throughout  the  world 
according  to  the  laws  of  the  distribution  of  gold.     The 
distribution  of  gold  may  well  be  illustrated  by  compar- 
ing it  with  water  poured  into  one  of  a  series  of  vessels 
connected  by  pipes.     Water  poured  into  one  vessel  dis- 
tributes itself  through  all  the  connected  series  so  that 
one  level  is  maintained  throughout  the  whole.     If  the 
pipes  are  small  or  clogged  up  there  may  be  considerable 
delay  in  the  distribution  of  the  water.     In  the  case  of 
gold  there  may  be  for  short  periods  of  time  inequalities 
in  the  distribution  of  gold  which  are  to  be  accounted  for 
by  disturbances  in  the  machinery  of  exchange;  ulti- 
mately, however,  gold  will  find  its  level  throughout  the 
world. 

106.  Factors  in  the  supply  of  gold. — The  supply  of 
gold  is  determined  by  the  same  factors  which  determine 
the  price  of  any  other  commodity.     There  is  always  a 
tendency  for  the  supply  to  be  increased  so  long  as  there 
is  a  profit  in  its  production.     If  the  cost  of  producing 
gold  is  considerably  below  its  value  there  will  be  a  strong 
inducement  to  enlarge  the  operation  of  mines  and  to 


84  MONEY  AND  BANKING 

prospect  for  new  mines.  However,  as  the  quantity  of 
gold  in  circulation  increases,  the  effect  will  be  to  raise 
prices  as  shall  presently  be  explained.  This  rise  of 
prices,  affecting  as  it  does  all  the  implements  and  ma- 
terials used  in  mining  as  well  as  the  wages  of  the  miners, 
increases  the  cost  of  production  and  thus  diminishes  the 
margin  of  profit  made  in  the  production  and  the  value 
of  gold  until  all  the  profit  of  mining  may  disappear  in 
the  mines  which  have  the  highest  cost  of  production, 
causing  them  to  shut  down  and  cease  contributing  to  the 
supply.  In  this  way  the  production  of  gold  is  auto- 
matically regulated. 

107.  Peculiarity  of  the  supply  of  gold. — There  is  a 
peculiarity  in  connection  with  the  supply  of  gold  which 
distinguishes  it  from  any  other  commodity.     The  sup- 
ply of  a  commodity  may  be  considered  as  a  sum  of  util- 
ities which  satisfy  human  want.     The  supply  of  wheat 
when  analyzed  means  the  number  of  units,  each  of  which 
has -a  certain  power  to  satisfy  hunger.     Two  bushels 
of  wheat  have  twice  as  much  power  in  this  respect  as 
one. 

In  the  case  of  gold,  however,  the  utility  consists  of 
its  power  to  exchange  other  commodities.  Now  there 
is  no  reason  at  all  why  one  grain  of  metal  might  not  do 
just  as  much  work  of  exchanging  commodities  as  one 
ounce.  If  the  quantity  of  gold  in  the  world  is  doubled 
at  the  same  time  that  the  prices  of  goods  in  general  are 
doubled,  the  increased  quantity  of  gold  will  do  no  more 
money  work  than  the  original  amount,  and  the  money 
supply  of  the  world  has  not  been  increased  at  all  when 
measured  by  its  effectiveness. 

108.  Historical  illustrations. — There  have  been  three 
periods  in  history  which  illustrate  this  general  proposi- 
tion very  clearly.     The  great  increase  in  the  amount  of 


SUPPLY  AND  DEMAND  85 

silver  in  the  world  after  the  discovery  of  America  and 
the  opening  up  of  South  American  and  Mexican  silver 
mines  by  the  Spaniards  in  the  sixteenth  century  caused 
a  tremendous  change  of  prices  for  every  commodity. 

The  discovery  of  gold  in  California  and  Australia  in 
the  middle  of  the  nineteenth  century  was  followed  by  a 
similar  rise  in  general  prices.  At  the  present  time  we 
are  undergoing  a  period  of  increased  gold  production, 
especially  in  South  Africa  and  accompanying  high 
prices. 

In  each  of  these  periods  the  great  enlargement  of  the 
stock  of  standard  money  in  the  world  produced  a  pro- 
found social  effect  and  radically  altered  the  relations 
between  debtors  and  creditors.  The  small  quantity  of 
money  metal  in  existence  before  these  discoveries  were 
made  would  to-day  do  just  as  much  work  if  there  had 
been  no  increase,  but  the  level  of  prices  would  be  very 
low  indeed.  The  value  of  the  dollar  would  easily  be  ten 
times  what  it  is  to-day  and  25  cents  would  be  a  fair  day's 
wage  for  the  unskilled  workingman. 

This  ridiculously  low  level  of  prices,  however,  would 
not  mean  anything  at  all  if  all  values  were  in  the  same 
proportion.  If  the  necessities  of  life  cost  one-tenth  of 
the  price  which  we  are  paying  to-day,  25  cents  per  day 
wages  would  be  as  satisfactory  to  the  laborer  as  $2.50  is 
under  present  conditions. 

109.  Temporary  results  of  change  of  money  supply. 
— While  it  makes  little  difference  whether  the  absolute 
price  level  is  high  or  low  so  long  as  relative  values  are 
unchanged,  yet  changes  in  the  price  level  are  likely  to 
have  great  economic  results  because  the  price  of  every 
commodity  that  is  bought  and  sold  does  not  change 
equally  or  simultaneously.  Therefore  a  change  in  the 
general  price  level  is  likely  to  cause  a  general  change  in 


86  MONEY  AND  BANKING 

the  relative  values.  Especially  is  this  true  of  credits. 
If  a  debtor  has  promised  to  pay  a  creditor  $100  in  ten 
years,  and  if  within  that  period  prices  have  changed  so 
that  the  $100  at  maturity  represents  the  equivalent  of 
only  half  the  quantity  of  goods,  the  creditor  has  in  real- 
ity received  only  half  as  much  in  value  as  he  loaned. 
The  fact  that  he  received  the  same  number  of  dollars 
does  not  mean  anything  because  the  dollars  to  him  are 
valuable  only  as  he  can  exchange  them  for  things  that 
he  wants. 

110.  Effect  of  increased  supply  of  gold  traced  out. — 
The  principles  which  have  been  stated  above  will  be 
better  understood  if  we  examine  the  effect  of  the  addi- 
tion of  a  certain  quantity  of  gold  to  the  stock  already 
on  hand.  Let  us  follow  the  output  of  a  mine  and  trace 
out  the  ultimate  effects  of  the  new  gold. 

When  the  gold  has  been  refined  and  made  into  bricks 
it  is  sent  to  a  Government  assay  office,  where  it  is  tested 
to  determine  its  purity,  and  then  turned  over  to  the 
mint.  Theoretically,  under  a  system  based  on  the  free 
coinage  of  gold  anybody  can  take  the  metal  to  the  mint 
with  the  proper  amount  of  alloy  needed  to  harden  it  for 
purposes  of  circulation  and  can  have  it  transformed  into 
coins.  Practically,  however,  the  gold  bricks  are  taken 
to  the  mint,  but  instead  of  waiting  until  the  gold  has 
been  made  into  coins  the  owner  receives  at  once  the 
money  equivalent  for  its  value.  The  person  who 
brought  the  gold  to  the  mint  now  has  the  corns  or  their 
equivalent  in  some  other  form.  He  will  either  spend 
this  money  or  deposit  it  in  a  bank.  If  he  goes  into  the 
market  to  purchase  goods  of  any  sort  his  buying  will 
have  the  effect  of  bidding  up  prices  proportionately 
and  the  gold  which  was  mined  will  be  responsible  for 
whatever  effect  has  been  produced  on  prices.  The  mer- 


SUPPLY  AND  DEMAND  87 

chant  who  received  the  money  uses  it  to  replenish  his 
stock  and  his  buying  will  tend  to  raise  the  prices  of  his 
purchases. 

As  the  money  circulates  from  hand  to  hand,  at  every 
exchange  it  will  tend  to  raise  prices.  This  continuous 
process  of  price  raising,  spreading  through  all  the  dif- 
ferent markets,  would  seem  to  have  no  end.  It  would 
seem  that  if  we  took  one  dollar  and  gave  it  time  and 
rapidity  of  circulation  enough  it  might  raise  the  general 
price  level  to  any  height. 

111.  Limit  to  the  price-raising  effect  of  gold. — This 
reductio  ad  absurdum  is  answered  by  another  proposi- 
tion which  counteracts  it.     Every  rise  of  price  reduces 
the  purchasing  value  of  the  dollar,  so  that  as  the  dollar 
continues  to  circulate  it  lose  its  power  to  exchange  goods 
in  the  exact  proportion  as  they  have  risen,  so  that  if  we 
conceive  prices  to  have  exactly  doubled  it  will  require 
$2.00  to  exchange  them  where  it  only  required  one  be- 
fore.    The  result  will  be  that  there  will  be  an  equilib- 
rium of  prices  established  at  a  higher  level  than  before 
the  increase  in  the  quantity  of  money. 

If  the  quantity  of  money  should  be  diminished  in 
amount,  or  if  the  quantity  of  goods  to  be  exchanged 
should  be  doubled,  there  would  be  a  lowering  of  prices 
to  correspond  on  account  of  the  increase  in  the  offering 
of  goods  for  sale  without  the  corresponding  amount  of 
bidding  from  the  owners  of  cash  to  pay  for  them.  The 
result  would  be  the  formation  of  a  new  level  of  prices 
at  a  point  where  the  offerings  of  goods  and  the  bidding 
of  the  holders  of  cash  would  balance. 

112.  Alternative  uses  of  new  gold. — If  the  miner 
who  has  increased  the  money  supply  of  the  country  with 
the  product  of  his  mine  should  choose  to  hold  the  gold 
coins  or  the  paper  money  equivalent  for  the  gold,  there 


88  MONEY  AND  BANKING 

would  be  no  effect  whatever  on  prices,  and  it  would  be 
as  though  he  had  stored  away  the  gold  bricks  or  had 
never  produced  the  gold  at  all. 

However,  if  he  deposits  it  in  the  bank  its  effect  there 
will  be  to  increase  the  loaning  power  of  the  bank  and 
thereby  to  increase  the  purchasing  power  of  the  bor- 
rowers of  the  bank  and  thus  affect  prices  even  more. 

113.  Widespread  effect  of  new  gold. — An  increase 
of  prices  on  account  of  any  large  addition  to  the  money 
supply  would  have  more  than  local  effect.  We  have 
seen  how  purchases  from  the  retail  dealers  would 
tend  to  increase  wholesale  prices  in  the  central  markets 
on  account  of  the  additional  purchases  of  the  retailer 
to  replenish  his  stock.  In  the  same  way  the  influence 
would  extend  from  the  central  markets  to  the  producing 
centers  in  this  country  and  abroad.  The  demand  for 
imported  goods  would  be  increased  and  unless  our  ex- 
ports happened  to  increase  at  the  same  time  the  result 
would  be  an  export  of  gold  to  foreign  countries.  If 
the  general  price  level  was  raised  in  this  country  there 
would  be  an  increased  profit  in  importing  goods,  and  a 
corresponding  decrease  of  profit  in  exporting  them,  un- 
til, if  the  gold  production  or  other  increase  in  the  supply; 
of  money  was  great  enough,  there  might  be  no  exports 
at  all  and  we  might  be  forced  to  settle  for  all  our  im- 
ports with  gold. 

Following  out  this  principle  we  may  conclude  that  the 
only  advantage  which  a  country  derives  from  a  large 
production  of  gold  is  simply  that  it  is  the  first  to  feel 
the  effect  on  prices;  it  cannot  expect  to  retain  perma- 
nently any  more  than  its  proper  share  of  the  new  gold  so 
long  as  trade  is  free  between  it  and  foreign  countries. 
It  would  be  impossible  to  increase  permanently  the  sup- 
ply of  gold  in  this  country  without  giving  the  other 


SUPPLY  AND  DEMAND  89 

countries  their  proper  proportionate  share  of  it  unless 
we  used  it  as  a  substitute  for  other  forms  of  money 
which  were  retired  from  circulation  to  make  a  place 
for  it. 

114.  Comparison  of  effect  of  increase  of  supply  of 
gold  and  paper  money. — Following  out  this  principle 
further  in  connection  with  fiat  and  credit  money  it  will 
appear  that  it  is  impossible  for  a  country  to  increase  its 
supply  of  these  forms  of  money  and  keep  them  at  a 
parity  with  gold  unless  there  has  been  an  increase  in 
the  demand  for  money  due  to  enlarged  volume  of 
business,  increased  population,  etc. 

Suppose  the  Government  were  to  issue  $500,000,000 
new  United  States  notes  in  addition  to  the  $346,000,000 
already  outstanding  in  circulation.  Suppose  these  notes 
were  paid  out  by  the  Government  for  extraordinary 
expenditures  occasioned  by  some  great  public  enterprise, 
such  as  the  building  of  a  canal  or  for  materials  to  carry 
on  a  war.  These  notes  would  go  into  circulation  and 
cause  the  same  rise  in  prices  as  an  equal  output  of  gold. 
The  higher  prices  would  attract  imports  and  discourage 
exports  and  there  would  be  credited  against  us  a  debit 
balance  which  would  have  to  be  settled  in  gold  sooner 
or  later.  In  this  way  the  issue  of  notes  would  continue 
to  drive  gold  out  of  the  country  by  attracting  into  the 
country  an  equivalent  amount  of  goods  from  foreign 
countries  until  a  new  equilibrium  of  prices  throughout 
the  world  were  established.  When  so  much  gold  has 
been  driven  out  that  it  becomes  difficult  for  the  bankers 
to  find  gold  for  export,  the  Government  would  probably 
be  unable  to  maintain  the  new  notes  on  a  par  with  gold, 
and  there  would  appear  all  the  phenomena  which  accom- 
pany a  depreciated  currency,  about  which  we  shall  have 
much  to  say  in  a  later  chapter. 


90  MONEY  AND  BANKING 

115.  How  much  money  is  needed  in  a  country? — Fif- 
teen years  ago  we  heard  a  great  deal  in  this  country 
about  the  scarcity  of  money,  and  one  of  the  strongest 
arguments  of  the  Silver  Party  was  that  the  country 
needed  more  money  to  do  business  properly.  They  said 
that  goods  were  unsalable  because  there  was  not  the 
money  to  purchase  them.  If  the  principles  which  we 
have  worked  out  above  are  true,  it  would  be  of  no  use 
whatever  to  increase  the  quantity  of  money  in  the  coun- 
try because  if  we  increased  the  amount  we  should  dimin- 
ish its  exchanging  power  proportionately  and  the  net  re- 
sult would  be  that  our  $2.00  would  do  no  more  work  than 
the  $1.00  did  before.  We  might  even  go  so  far  as  to 
say  that  a  country  always  has  enough  money  to  take  care 
of  its  business  needs;  however,  such  a  statement  would 
be  misleading  if  we  did  not  take  into  consideration  the 
effect  of  fluctuating  prices  upon  industry. 

The  real  difficulty  of  which  the  silver  reformers  com- 
plained was  not  the  insufficient  quantity  of  money,  but 
the  low  level  of  commodity  prices.  They  pointed  to  the 
western  farmer,  who  was  compelled  to  accept  less  than 
fifty  cents  a  bushel  for  his  wheat.  There  was  plenty  of 
money  in  the  country  to  pay  for  the  wheat  and  the 
farmer  was  really  complaining  because  of  the  low  price 
rather  than  because  of  the  lack  of  a  market  for  the 
wheat.  If  everything  the  farmer  had  to  purchase  with 
the  proceeds  of  his  crops — supplies  for  the  family, 
wages  of  his  hired  labor,  taxes,  interest  and  principal 
on  borrowed  money,  were  diminished  proportionately, 
he  would  have  had  no  reason  to  complain.  The  trouble 
was  that  the  prices  of  these  things  did  not  diminish  pro- 
portionately with  the  price  of  wheat.  In  the  course  of 
time  values  would  adjust  themselves  in  the  same  pro- 
portions as  before. 


SUPPLY  AND  DEMAND  91 

116.  Price  changes  not  synchronous. — In  the  long 
run  the  quantity  of  money  has  little  effect  in  altering 
relative  values;  for  a  short  period  of  time,  however,  it 
has  a  very  great  effect.     The  reason  of  this  is  that  some 
commodities  are  very  susceptible  to  money  influences 
and  respond  quickly  to  changes  in  the  money  supply, 
while  others  respond  very  slowly.     Stocks  and  the  spec- 
ulative commodities,  such  as  wheat,  cotton,  copper,  iron, 
etc.,  are  very  easily  and  quickly  influenced;  wholesale 
prices  probably  feel  the  effect  much  sooner  than  retail 
prices,  in  which  the  influence  of  custom  plays  a  greater 
part.     Wages  feel  the  change  considerably  later,   so 
that  during  a  general  rise  of  prices  the  workingman  is 
at  a  disadvantage  in  having  to  pay  more  for  the  food 
and  other  necessities  before  his  wages  are  increased  cor- 
respondingly.    Contracts  for  the  payment  of  money  in- 
crease not  at  all. 

The  question  of  the  supply  of  money  is  an  extremely 
vital  one  because  of  its  bearing  upon  our  business  rela- 
tions due  to  the  variation  in  the  response  of  various 
values  to  the  change  in  the  quantity  of  money.  Changes 
in  the  supply  of  money  alter  the  relation  of  one  class 
to  their  advantage  and  to  the  disadvantage  of  another 
class.  An  increase  in  the  supply  of  money  puts  cred- 
itors at  a  disadvantage  and  favors  debtors;  it  increases 
the  profits  of  the  producers  of  raw  materials  at  the  ex- 
pense of  the  wage  earners,  more  especially  to  the  disad- 
vantage of  the  recipients  of  fixed  incomes. 

117.  Stimulating  effect  of  rising  prices. — There  is 
one  effect  of  increased  money  supply,  the  benefit  of 
which  has  no  corresponding  disadvantage  for  the  time 
being.     Rising  prices  of  commodities  stimulate  industry 
and  increase  the  demand  for  labor  for  the  materials 
which  enter  into  capital  goods.     This  increase  in  indus- 


92  MONEY  AND  BANKING 

trial  activity  leads  to  the  greater  production  of  wealth 
in  the  form  of  consumption  goods  and  means  a  greater 
per  capita  distribution.  Therefore,  economists  have 
concluded  that  a  condition  of  gradually  increasing  prices 
is  the  ideal  one  for  any  community  and  since  it  is  within 
the  power  of  a  community  through  the  agency  of  Gov- 
ernment to  regulate  the  rise  and  fall  of  prices  through 
the  manipulation  of  the  supply  of  money,  it  is  possible 
to  make  great  economic  improvements  by  this  means,  as 
we  shall  discover  in  a  more  detailed  examination  later. 

118.  Reaction. — There  is  as  much  to  fear  from  rising 
as  from  falling  prices  if  the  tendency  toward  higher 
price  levels  is  allowed  to  run  into  speculation,  the  over- 
expansion  of  credit  and  the  inevitable  collapse  which  fol- 
lows.    Whether  it  is  possible  for  a  Government  to  so 
regulate  the  rise  of  prices  through  the  manipulation  of 
the  supply  of  money  that  the  evil  consequences  can  be 
avoided  is  a  matter  which  may  one  day  become  of  great 
importance,  especially  if  the  unregulated  production  of 
gold  should  go  on  increasing  at  too  great  a  rate. 

In  the  present  chapter  we  have  seen  that  the  value 
of  gold  and  conversely  the  general  level  of  prices  is  de- 
termined by  the  supply  of  and  demand  for  money.  The 
value  of  money  at  any  particular  moment  represents  the 
equilibrium  between  these  two  forces.  Each  of  the 
forces,  however,  is  composed  of  a  great  number  of  tend- 
encies. Sometimes  there  may  be  a  particularly  large 
demand  for  gold  in  order  to  exchange  a  large  volume 
of  produce,  while  at  the  same  time  the  demand  for  gold 
as  a  store  of  value  may  decline;  the  force  of  demand 
therefore  is  the  final  result  of  a  number  of  tendencies 
and  countertendencies. 

119.  Swings    of    prices. — An    estimation    of    the 
strength  of  the  demand  for  money  at  any  particular 


SUPPLY  AND  DEMAND  93 

time  or  a  prediction  as  to  a  future  demand  is  facilitated 
by  the  fact  that  the  changes  occur,  not  abruptly,  but  in 
great  swings.  These  great  swings  in  the  value  of  gold 
are  simply  manifestations  of  that  great  law  of  nature 
by  which  all  progress  occurs  rhythmically  and  not  stead- 
ily in  any  given  direction.  The  course  of  prices  on  the 
stock  exchange,  the  recurring  periods  of  depression  and 
prosperity,  the  great  cycles  of  rainfall,  are  examples  of 
this  great  natural  law  which  is  found  to  prevail  gener- 
ally throughout  the  universe. 

120.  Cumulative  effect  of  economic  forces. — The  ex- 
planation of  these  great  economic  swings  of  prices  and 
values  is  to  be  found  in  the  cumulative  effect  of  the 
economic  forces.  We  are  all  familiar  with  the  general 
pessimism  that  hangs  like  a  cloud  over  the  community 
during  an  economic  depression.  The  obvious  fact  that 
the  existing  supply  of  goods  is  steadily  diminishing, 
that  the  savings  deposits  of  the  people  are  increasing 
in  amount  in  consequence  of  the  hard  lesson  of  thrift 
which  the  people  have  learned  in  the  hard  times,  in 
spite  of  the  steady  deterioration  in  the  industrial  equip- 
ment of  the  country,  the  wearing  out  of  the  rails  and 
rolling  stock  of  the  railroads — all  these  factors  instead 
of  inspiring  confidence  for  the  future  among  business 
men  are  even  used  as  an  argument  for  continued  hard 
times. 

When  the  inevitable  demand  for  goods  which  has  tem- 
porarily been  delayed  finally  begins  to  assert  itself,  at 
first  slowly,  the  business  community  gradually  begins  to 
hope  that  prosperity  is  returning.  As  the  prosperity 
continues  the  cumulative  effect  of  returning  confidence 
makes  itself  felt  in  increasing  prices,  and  since  increas- 
ing prices  mean  larger  profits  to  anybody  owning  any 
kind  of  property  except  money  itself,  there  arises  an 


94  MONEY  AND  BANKING 

enormous  demand  for  income  yielding  property  of  all 
sorts,  even  that  which  promises  to  return  only  a  specu- 
lative profit. 

When  industry  is  at  its  height  and  prices  have  been 
put  to  record  breaking  levels  everybody  is  optimistic  and 
hopeful  of  still  better  conditions.  It  is  at  a  time  like 
this  that  the  careful  observer  will  note  that  the  produc- 
tion of  both  consumption  and  production  goods  has  in- 
creased tremendously  and  will  likely  soon  surpass  the 
needs  of  the  community.  He  will  note  that  the  higher 
prices  go  the  smaller  is  the  prospect  of  still  further  ad- 
vance and  the  greater  the  prospect  of  a  recession  to 
lower  levels.  He  will  note  that  the  rate  of  interest  is 
very  high,  indicating  a  scarcity  in  the  supply  of  loanable 
funds.  His  conclusion  from  this  state  of  affairs  will  be 
that  in  the  near  future  there  must  inevitably  be  a  greater 
demand  for  money  and  a  consequent  increase  in  its 
value.  He  also  will  remember  from  previous  experi- 
ence that  the  cumulative  effect  of  human  cupidity  and 
optimism  which  has  carried  prices  to  abnormally  high 
levels  will  have  exactly  the  reverse  effect  when  it  is 
turned  in  the  opposite  direction.  When  the  turn  comes 
and  the  downward  tendency  begins  a  corresponding 
scramble  to  dispose  of  goods  and  to  get  money  in  order 
to  realize  the  increase  in  value  will  set  in. 

These  great  swings  in  prices  offer  an  explanation 
of  the  fact  that  for  long  periods  of  time  an  increased 
demand  for  money  has  seemed  to  be  accompanied  by 
a  fall  in  value  of  money  instead  of  a  rise.  The  natural 
effect  of  demand  in  this  case  is  simply  suspended  for 
the  time  being,  but  when  it  again  asserts  itself  it  will  do 
so  with  far  more  than  the  ordinary  consequences  and 
values  will  be  carried  much  lower  than  they  otherwise 
would  be. 


CHAPTER  VIII 

THEORY  OF  PRICES 

121.  "Short"   sales   of   money. — Every   buyer   and 
seller  whatsoever  is  a  speculator  in  money,  though  he 
may  not  realize  it.    Every  debtor  and  creditor  is  not  only 
a  speculator  in  money  but  he  is  a  speculator  in  "fu- 
tures."    Every  debtor  has  sold  money  short  in  exactly 
the  same  way  as  a  speculator  on  the  board  of  trade  has 
sold  wheat  short  when  he  has  contracted  to  deliver  a  cer- 
tain number  of  bushels  at  a  given  price  at  a  future  time. 
He  gains  or  loses  as  the  price  at  that  time  of  delivery 
has  fallen  or  risen. 

It  is  an  axiom  in  the  speculative  markets  that  there 
is  no  better  guaranty  for  the  maintenance  of  prices 
than  the  existence  of  a  large  short  interest,  the  reason 
being  that  those  persons  are  potential  purchasers  who 
must  buy  within  a  given  time  whether  they  wish  to  do 
so  or  not.  Thus  in  times  of  credit  expansion  when  peo- 
ple are  going  into  debt  in  order  to  extend  their  business 
or  for  the  purpose  of  buying  something  which  they  hope 
to  sell  at  a  higher  price  later,  a  large  short  interest  in 
money  is  being  created  and  as  the  time  of  maturity  ap- 
proaches it  is  inevitable  that  there  must  occur  a  scram- 
ble for  money  with  which  to  satisfy  the  credit  contracts. 

122.  " Squeezing  the  shorts"-— When  the  credit  ex- 
pansion has  extended  to  an  extraordinary  degree  there 
are  not  lacking  shrewd  bankers  and  experts  in  finance 
who  realize  the  approaching  demand  for  money  before 
the  ordinary  business  community;  these  men  quietly  ac- 

95 


96  MONEY  AND  BANKING 

cumulate  a  store  of  funds.  They  may  do  this  to  such 
an  extent  that  there  suddenly  develops  a  condition  which 
might  almost  be  called  a  corner  in  money  and  a  squeez- 
ing of  shorts  follows.  This  process  of  "squeezing"  the 
money  shorts  is  more  familiar  under  the  name  of  a 
money  panic. 

A  man  who  finds  himself  obliged  to  make  a  payment 
at  a  certain  time  has  a  choice  of  one  of  two  courses;  he 
may  either  borrow  or  he  may  sell  something  he  possesses 
in  order  to  provide  himself  with  funds.  In  a  severe 
money  panic  it  is  practically  impossible  to  borrow 
money,  even  upon  the  most  select  collateral,  and  there 
have  been  days  on  the  stock  exchange  when  call  money 
ran  as  high  as  186  per  cent  per  annum. 

123.  Forced  selling. — Under  such  conditions  the  only 
recourse  of  the  debtor  is  to  sell  whatever  property  he 
possesses  at  the  best  price  obtainable.     This   sudden 
pressure  of  selling  upon  a  market  which  is  disinclined  to 
buy  will  permit  prices  to  descend  to  a  level  which  would 
have  seemed  absolutely  ridiculous  a  few  months  previ- 
ous.    There  are  not  wanting  at  such  times  shrewd  peo- 
ple who  realize  that  there  are  extraordinary  bargains 
to  be  found,  but  it  is  only  a  few  of  these  shrewd  people 
who  have  the  means  to  buy  at  such  times.     The  great 
majority  of  people,  however,  do  not  recognize  these  bar- 
gains, even  if  they  have  the  funds ;  and  instead  of  buy- 
ing in  a  market  which  offers  them  a  practical  certainty 
of  an  increase  of  25  to  100  per  cent  on  their  investment, 
they  prefer  to  keep  it  stored  away  until  the  stringency  as 
well  as  the  bargains  have  become  a  thing  of  the  past. 

124.  People  becoming  better  educated. — There  is  evi- 
dence, however,  in  the  panic  of  1907  that  the  people  in 
general  are  learning  to  take  advantage  of  the  occasional 
opportunities  which  tHese  great  swings  of  prices  offer 


THEORY  OF  PRICES  97 

them.  The  books  of  the  great  corporations  such  as  the 
United  States  Steel  Corporation,  the  Pennsylvania  Rail- 
road and  hundreds  of  others,  show  a  great  increase  in  the 
number  of  stockholders  after  October,  1907.  This  is  a 
most  hopeful  sign  that  in  the  future  as  the  people  be- 
come better  educated  in  financial  affairs  the  fluctuations 
in  values  will  become  less  and  less  pronounced.  It 
would  be  impossible  to  overestimate  the  great  effect  in 
this  direction  which  the  recent  large  output  of  literature 
on  financial  subjects  has  brought  about. 

125.  General  price  level. — Whenever  we  have  spoken 
of  the  effect  of  changes  in  the  value  of  money  on  prices 
we  have  always  spoken  of  it  as  a  change  in  the  "general 
price  level."     The  rising  or  falling  of  prices  due  to  a 
change  in  the  money  supply  or  demand  is  slow  and 
gradual,  while  the  changes  in  prices  due  to  causes  af- 
fecting the  supply  and  demand  for  goods  may  be  sharp 
and  sudden.     Furthermore,  the  prices  of  some  goods 
may  be  rising  while  the  prices  of  others  are  falling. 

126.  Price  tables. — In  the  first  place,  therefore,  it  is 
necessary  in  estimating  the  effect  of  money  to  eliminate 
all  those  causes  which  account  for  changes  in  the  prices 
of  goods.     In  order  to  observe  the  changes  in  the  gen- 
eral price  level  price  tables  have  been  constructed.     The 
ideal  price  table  would  of  course  represent  the  average 
price  changes  of  all  the  commodities,  the  exchange  of 
which  creates  a  demand  for  money.     Since  this  is  im- 
possible the  most  practical  method  is  to  take  a  certain 
number  of  representative  commodities. 

127.  Many  commodities. — Such  a  table  must  not  be 
confined  to  a  few  commodities  nor  to  one  class,  because 
there  might  be  special  causes  for  an  advance  of  prices 
of  that  particular  class.     An  instance  of  this  would  be 
in  commodities  representing  natural  resources  and  raw 

VII— 7 


98  MONEY  AND  BANKING 

materials.  A  price  table  composed  of  wheat,  corn,  lum- 
ber, coal,  cotton,  would  show  a  rise  in  price  in  the  last 
ten  years  much  greater  than  could  be  attributed  to  any 
change  in  the  value  of  money.  The  reason  for  such  a 
change  would  be  the  increase  of  population  relative  to 
the  supply  of  natural  resources  or  the  area  of  land 
producing  them. 

On  the  other  hand,  if  we  made  a  price  table  composed 
of  solely  such  articles  as  silk  cloth,  watches,  articles  man- 
ufactured from  fine  metals,  etc.,  we  should  find  that  the 
average  price  had  probably  fallen  within  the  last  ten 
years,  the  reason  being  that  with  the  improvement  in 
labor-saving  machinery  and  the  greater  skill  of  modern 
workmen  the  cost  of  production  was  considerably  dimin- 
ished, so  that  the  fall  in  price  would  more  than  offset 
any  diminution  in  the  value  of  money. 

128.  Example  of  price  table. — It  is  therefore  clear 
that  a  price  table  should  be  composed  of  such  a  variety 
of  commodities  that  the  influences  affecting  the  value  of 
the  particular  classes  will  counterbalance  each  other. 
The  proposition  has  been  stated  above  that  a  general 
rise  of  values  is  absolutely  impossible  in  the  nature  of 
things,  since  value  is  a  ratio,  and  it  is  impossible  to  alter 
the  relation  of  things  by  equal  changes  on  each  side. 
We  give  below  a  sample  in  outline  of  a  price  table  con- 
structed to  show  the  price  changes  over  a  period  of  two 
years: 

1890  %  1892  % 


Wheat  

,  $     1.00 

100 

$     1.10 

110 

Cattle  

50.00 

100 

60.00 

120 

Knives  

,  20.00 

100 

15.00 

75 

Silk  cloth  

,  150.00 

100 

120.00 

80 

4) 

400 

385 

100  96-% 

In  this  table  we  have  made  a  hypothetical  list  of  the 


THEORY  OF  PRICES  99 

prices  in  1890  and  another  for  the  year  1892.  These 
prices  should  preferably  represent  an  average  for  a  pe- 
riod of  time  in  order  to  avoid  any  accidental  fluctua- 
tions due  to  the  season  or  other  temporary  causes.  The 
prices  for  1890  have  been  made  the  basis  at  100  per  cent 
and  the  increase  or  decrease  calculated  with  reference  to 
this  base.  This  table  will  show  that  while  some  prices 
have  advanced  others  have  fallen  so  that  the  general 
level  is  diminished  3%  per  cent. 

129.  "Weighting"  of  price  tables. — It  may  be  ob- 
jected that  in  this  table  we  have  given  exactly  as  much 
importance  to  knives  as  we  have  to  wheat,  whereas  we 
know  that  a  change  of  a  cent  a  bushel  in  wheat  would 
have  vastly  greater  effect  on  the  demand  for  money  than 
a  change  of  100  per  cent  in  the  value  of  knives.  To  cor- 
rect this  difficulty  a  system  has  been  devised  for  "weight- 
ing" the  various  items  in  a  price  table.  The  principle 
of  "weighting"  is  to  find  some  basis  of  estimating  the 
amount  of  the  particular  items  and  exchange  either  on 
the  basis  of  total  production  or  consumption. 

To  weight  our  price  table  above  it  would  be  necessary 
to  arrange  the  four  items  so  that  wheat  would  have  an 
influence  on  the  result  let  us  say  one  hundred  times  as 
great  as  knives;  that  cattle  would  have  an  importance 
fifty  times  as  great  as  knives;  that  silk  cloth  has  an  im- 
portance say  ten  times  as  great  as  knives.  The  table 
modified  to  conform  to  this  weighting  arrangement  is 
given  below: 

1890  1892 

Wheat 100  X  $     1.00  =  10000  $     1.10  =  110000 

i             Cattle 50  x      50.00  =   5000  60.00  =  6000 

Knives   1  X      20.00  =     100  15.00  =       75 

Silk  cloth  . ,                    10  X    150.00  =   1000  120.00  =     800 


161  16100  17875 


100%  111  4-161% 

While  the  weighting  of  the  price  table  seems  to  pro- 


100  MONEY  AND  BANKING 

duce  a  very  great  effect  upon  our  sample  table,  yet  in 
making  actual  tables  where  the  number  of  commodities 
is  much  greater  the  differences  shown  by  simple  and 
weighted  price  tables  are  very  slight,  and  since  the  total 
result  of  any  price  table  is  but  an  approximation,  it  is 
doubtful  whether  the  weighted  price  tables  are  more 
nearly  accurate  than  the  simple  price  tables. 

130.  Advantages  of  weighting. — The  principle  of 
weighting  is  important  when  changes  in  the  price  level 
for  certain  purposes  are  desired.     For  instance,  if  we 
desire  to  know  whether  the  average  cost  of  living  for 
the  workingman's  family  has  increased  or  decreased,  the 
price  table  should  not  only  show  the  items  which  enter 
into  the  consumption  of  the  family  but  they  should  be 
weighted  to  show  their  importance  in  the  family  budget. 
Tables  constructed  upon  this  principle  were  prepared 
by  Professor  Falkner  in  the  most  elaborate  investigation 
of  prices  that  has  ever  been  undertaken  in  this  country. 
The  report  was  prepared  for  a  Committee  of  the  Sen- 
ate.1 

131.  Falkner  price  table. — For  this  table  lists  of 
prices  of  90  commodities  were  covered  from  1840  to 
1891 ;  and  223  commodities  were  covered  for  the  period 
from  1860  to  1891.     The  investigation  was  conducted 
with  great  care  and  expense,  the  prices  being  ascertained 
from  an  examination  of  merchants'  accounts.     Several 
tables  were  prepared  from  this  data  which  are  repro- 
duced herewith.     In  the  first  table  the  average  per- 
centage of  prices  for  various  groups  of  commodities  is 
given  separately,  the  year  1860  being  taken  as  a  basis, 
or  100  per  cent.     The  average  prices  of  all  the  com- 

i  Report  by  Senator  Aldrich  for  the  Committee  on  Finance,  March  3,  1893, 
Senate  Document,  52nd  Congress,  second  Session,  No.  1394,  "Wholesale 
Prices,  Wages  and  Transportation." 


THEORY  OF  PRICES 


101 


modities  taken  had  decreased  to  92.2  per  cent  in  1801, 
an  average  of  7.8  per  cent. 


FALKNER  PRICE  TABLE 


£ 

3 

o 

fc 

M> 

C 

1 

0 

T3 

i 

1 

0 

Food  and  Lighting  .  .  . 

Metals  and 
Implements  

Lumber  and  Build- 
ing Materials  

Drugs  and  Chemicals. 

House  Furnishing 
Goods  

Miscellaneous  

AU  Articles  | 

1840  

....     96.6 

1107 

395  8 

1235 

110  0 

145  8 

116  4 

147  1 

116  8 

1841  

....     94.4 

113.4 

2089 

123  7 

111  8 

141  3 

1164 

147  1 

115  8 

1842  

....     82.9 

100.9 

202.0 

118.7 

1088 

131  6 

1164 

170.6 

107  8 

1843  

....     79.3 

99.9 

187.5 

114.7 

105.4 

121.4 

100.3 

1235 

101.5 

1844  

....     81.6 

105.0 

119.7 

1333 

1030 

119  7 

1023 

129  5 

101  9 

1845  

....     87.3 

97.1 

239.6 

110.8 

106.7 

1210 

1023 

1148 

1028 

1846  

94.6 

953 

143.8 

116  9 

1062 

1239 

111  0 

111  0 

106  4 

1847  

....     94.7 

97.6 

110.7 

120.6 

108.2 

112.5 

120.3 

121  7 

106  5 

1848  

....     83.5 

87.5 

106.1 

119.7 

105.3 

113.0 

121.7 

125.6 

101.4 

1849  

79.0 

82.2 

100.0 

1249 

976 

111  0 

1205 

109  8 

987 

1850  

....     85.5 

91.3 

102.6 

114.8 

102.2 

123.6 

125.6 

107.7 

1023 

1851  

90.6 

94.7 

973 

1192 

972 

125  8 

1200 

102.7 

1059 

1852  

88.7 

88.7 

93.5 

117.7 

100.4 

111.8 

111.9 

1005 

102.7 

1853  

101.2 

98.6 

101.6 

122.8 

103.2 

107.0 

118.7 

109.2 

109.1 

1854  

105.9 

97.4 

106.8 

125.6 

114.1 

110.7 

121.2 

1084 

112.9 

1855  

111.8 

94.7 

121.1 

117.8 

103.4 

129.2 

121.2 

115.2 

113.1 

1856  

110.4 

100.6 

126.4 

115.3 

102.8 

135.5 

115.5 

121.6 

113.3 

1857  

117.5 

106.0 

113.3 

110.4 

105.0 

126.8 

116.8 

110.0 

112.5 

1858  

94.6 

98.0 

111.4 

101.3 

103.8 

116.0 

108.7 

97.1 

101.8 

1859  

98.8 

101.1 

98.8 

100.1 

98.7 

104.2 

103.2 

100.8 

100.2 

1860  

100.0 

100.0 

100.0 

100.0 

100.0 

100.0 

100.0 

100.0 

100.0 

1861  

95.8 

94.9 

103.5 

102.5 

108.9 

101.3 

96.8 

100.7 

100.6 

1862  

110.4 

124.1 

97.2 

117.2 

149.2 

116.4 

89.5 

103.7 

117.8 

1863  

133.0 

191.6 

107.1 

140.0 

177.1 

146.5 

123.1 

129.1 

148.6 

1864  

165.8 

260.7 

180.2 

179.8 

221.3 

170.3 

164.6 

154.4 

190.5 

1865  

216.5 

299.2 

237.8 

191.4 

182.1 

271.6 

181.1 

202.8 

216.8 

1866  

173.8 

226.6 

280.5 

171.1 

186.9 

230.2 

185.3 

171.0 

191.0 

1867  

163.9 

179.9 

196.3 

161.3 

178.8 

211.2 

159.1 

161.4 

172.2 

1868  

164.2 

146.8 

218.7 

150.5 

174.3 

177.9 

134.9 

164.1 

160.5 

1869  

162.9 

147.5 

206.8 

141.3 

165.9 

160.9 

120.7 

162.3 

153.5 

1870  

153.8 

139.4 

196.5 

127.8 

148.3 

149.6 

121.6 

148.7 

142.3 

1871  

169.3 

133.3 

144.1 

122.2 

151.4 

139.4 

128.5 

148.8 

136.0 

1872  

133.3 

143.0 

149.2 

128.0 

166.9 

134.0 

123.2 

132.7 

138.8 

1873   

129.8 

136.9 

134.6 

129.8 

171.9 

141.5 

109.1 

134.4 

137.5 

1874  

131.5 

127.9 

149.6 

121.1 

154.9 

146.8 

109.5 

129.8 

133.0 

1875  

130.5 

120.1 

156.5 

117.5 

143.7 

144.2 

95.0 

122.9 

127.6 

1876  

123.1 

107.5 

144.6 

108.4 

137.3 

121.8 

87.2 

114.2 

118.9 

1877   

120.3 

101.8 

108.0 

100.0 

125.8 

122.3 

79.0 

118.2 

110.9 

1878  

107.0 

93.2 

93.0 

92.1 

116.8 

114.2 

74.3 

111.7 

101.3 

1879  

97.6 

91.1 

95.3 

88.4 

115.1 

110.9 

68.6 

102.1 

96.6 

102 


MONEY  AND  BANKING 


60 

: 

3 

* 

q 

bO 

c 

13 

B 

SO 

i 

9 

*3    03 

§ 

C 

o 

J3 

B 

JS 

O 

& 

-M 
£* 

Sij 

§B 

6 

CO 

1 

1 

i 

T3 

1  a 

03 

B 

9 

tu 

«S 

(3 

t 

h 

TJ 

J3 

3  a 

00 

1  § 

8 

< 

8 

§ 

O 

§ 

V  1—  1 

3  ••* 

2 

oO 

-H 

h 

fc 

0 

h 

s 

i-l 

Q 

K 

i 

•< 

1880  

107.6 

104.5 

100.2 

96.3 

130.9 

113.1 

85.2 

109.8 

106.9 

1881  

110.9 

99.9 

113.7 

91.1 

131.3 

1104 

776 

1088 

105  7 

1882  

118.8 

98.7 

110.1 

91.2 

137.5 

107.6 

78.1 

114.6 

108.5 

1883  

118.8 

94.8 

114.2 

87.5 

134.3 

981 

77.5 

1173 

106  0 

1884  

108.9 

88.9 

102.4 

81.0 

129.5 

95.7 

76.3 

111.9 

99.4 

1885  

98.7 

84.8 

89.6 

77.4 

126.6 

86.9 

70.1 

97.5 

93.0 

1886  

99.5 

85.1 

86.2 

75.8 

128.5 

83.9 

68.4 

91.3 

91.9 

1887  

104.2 

84.7 

88.6 

74.9 

126.5 

83.6 

66.4 

88.6 

92.6 

1888  

109.4 

84.7 

94.9 

74.9 

124.8 

86.0 

66.9 

89.3 

94.2 

1889  

111.9 

83.6 

95.3 

72.9 

124.0 

88.8 

70.0 

88.8 

94.2 

1890  

104.6 

82.4 

92.5 

73.2 

123.7 

87.9 

69.5 

89.7 

92.3 

1891.. 

.   103.9 

81.1 

91.0 

74.9 

122.3 

86.3 

70.1 

95.1 

92.2 

In  the  second  table  we  have  a  tabulation  of  the  same 
data  in  weighted  form.  In  the  column  headed  III  the 
percentage  given  represents  the  average  for  all  articles 
according  to  their  importance  in  the  budgets  of  the 
average  family.  In  the  column  headed  IV  the  author 
attempts  to  reach  a  still  higher  point  of  accuracy  by 
assuming  that  the  articles  covered  in  the  data  represent 
over  68.6  per  cent  of  the  total  expenditures  of  each  fam- 
ily. The  difference  in  results  produced  by  these  dif- 
ferent methods  seems  to  be  rather  small. 

FALKNER  PRICE  TABLE  WEIGHTED 


1* 

"O  A      6o 

§J  a  I 

uu 

sa 

s  «3* 

£     «o  ^^ 

j 

a^ 

~*» 

&!2^» 

C8          0   S 

HH            bfi          3 

Si  *j  OD  *e 
*      W5    . 

^"*  »i 

1-1  'C  w 

H  «  c  *j  ±;  g 

f_5  <S  c  S  t*H  *^ 

cd   bo 

«2S 
•3.1s 

a  5+3 

WT3    C  'S    C 

V  s  1  1"2 

*  S  o  &-a 

—   eS   ft  tu   3 

"oS  C  °  5 
a  »-  as    .  ;g 

CO 

< 

< 

1840  

116.8 

98  5 

O7  •? 

1841  

1158 

qa  7 

oa  i 

1842...... 

107.8 

932 

on  i 

1843  

101.5 

89  3 

QA.  9 

THEORY  OF  PRICES 


108 


« 

'HI           bC 

PI  1 

Ui   t*   < 
Hi 

1*11 

MJJ 

_5  . 

•-"  *  60  °.  S 

>  *  to***  JJ 

9* 

*  &  . 

^•3^  |ig  g 

1-1  HT!  1^5 

•»  •  • 
•^  **  jy 

'•£  o  t  S  «2 

'•H  o  •£  *s  |j 

f  5  3 

Jj   0   O    x    C 

*  w  o  §  t» 

•—  1      r^     ^  ,  %j     P_, 

CO 

^ 

•"5 

1844  

101.9 

89.8 

85.0 

1845  

102.8 

92.1 

B&9 

1846  

106.4 

96.7 

95.2 

1847  ,, 

106.5 

96.7 

95.2 

1848...... 

101.4 

92.0 

885 

1849  

98.7 

88.9 

83.5 

1850  

102.3 

92.6 

89.2 

1851  

105.9 

99.1 

98.6 

1852  

102.7 

98.5 

97.9 

1853  

109.1 

103.4 

105.0 

1854  

112.9 

103.4 

105.0 

1855  

113.1 

106.3 

109.2 

1856  

113.2 

108.5 

1125 

1857  

112.5 

109.6 

114.0 

1858  

101.8 

109.1 

113.2 

1859  

100.2 

102.0 

102.9 

1860  

100.0 

100.0 

100.0 

1861  

100.6 

95.9 

94.1 

1862  

117.8 

102.8 

104.1 

1863  

148.6 

122.1 

132.2 

1864  

190.5 

149.4 

172.1 

1865  

216.8 

190.7 

232.2 

1866  

191.0 

160.2 

187.7 

1867  

172.2 

145.2 

165.8 

1868  

160.5 

150.7 

173.9 

1869  

153.5 

135.9 

1525 

1870  

1425 

130.4 

144.4 

1871  

136.0 

124.8 

136.1 

1872  

138.8 

122.2 

132.4 

1873  

137.5 

119.9 

129.0 

1874  

133.0 

120.5 

129.9 

1875  

127.6 

119.8 

128.9 

1876  

118.2 

115.5 

122.6 

1877  

110.9 

109.4 

113.6 

1878  

101.3 

103.1 

104.6 

1879  

96.6 

96.6 

95.0 

1880  

106.9 

103.4 

104.9 

1881  

105.7 

105.8 

108.4 

1882  

108.5 

106.3 

109.1 

1883  

106.0 

104.5 

106.6 

1884  

99.4 

101.8 

102.6 

1885  

93.0 

95.4 

935 

1886  

91.9 

95.5 

93.4 

1887  

92.6 

96.2 

94.5 

1888  

94.2 

97.4 

96.2 

1889  

94.2 

99.0 

98.5 

1890  

925 

95.7 

93.7 

1891  

92.2 

96.2 

94.4 

104.  MONEY  AND  BANKING 

182.  High  prices  during  the  Civil  War. — It  will  be 
noticed  that  the  prices  during  the  Civil  War  Period  are 
extremely  high,  the  percentage  for  the  year  1865  being 
216.8  per  cent.  The  reason  for  this  extraordinary  rise  is 
due  to  the  fact  that  the  prices  were  calculated  in  depre- 
ciated paper  money.  We  have  inserted  Table  No.  4 
showing  the  average  prices  reduced  to  a  gold  basis  dur- 
ing the  period  when  greenbacks  were  depreciated.  This 
table  will  show  to  what  extent  the  extraordinarily  high 
prices  of  the  Civil  War  were  due  to  the  inflated  paper 
currency.  As  we  have  explained  elsewhere,  most  of  the 
people  at  that  time  did  not  regard  the  paper  currency 
as  depreciated,  but  thought  gold  was  appreciated.1 
The  fact  that  there  was  nothing  connected  with  the  sup- 
ply and  demand  for  commodities  in  general  which  could 
account  for  the  more  than  doubling  of  the  prices  in  the 
year  1865  is  evidence  that  the  extreme  fluctuation  of 
prices  was  to  due  to  money  rather  than  to  goods. 

The  figures  we  have  spoken  of  as  percentages  are 
usually  called  index  numbers.  These  price  tables  pre- 
pared by  Professor  Falkner  are  continued  in  the  "Bul- 
letin of  the  Department  of  Labor," 2  and  the  index 
numbers  for  the  simple  table  for  the  period  from  1891 
to  the  present  time  are  given  on  the  following  page : 

iThe  demand  for  the  greenback  as  money  in  1862  must  certainly  have 
been  much  less  than  had  been  the  demand  for  gold  in  preceding  years, 
for  the  country  had  been  split  in  two,  so  that  the  monetary  demand  brought 
to  bear  upon  the  greenback  came,  for  the  most  part,  from  only  one  sec- 
tion.—  Johnson,  "  Money  and  Currency,"  p.  276. 

2  See  "  Bulletin  for  the  Department  of  Labor "  for  March  of  each  year. 
A  continuation  of  Professor  Falkner's  Tables  is  found  in  Bulletin  No.  27. 
The  Department  of  Labor  has  maintained  a  price  table  in  its  bulletins 
arranged  on  a  basis  different  from  that  of  the  Falkner  tables. 


THEORY  OF  PRICES 

COMPARISON  OF  VARIOUS  PRICE  TABLES 


105 


3->  O 

to  «5 

'S  * 
S '-' 

ll 

~ 


(American) 


(English) 


to 
(German) 


1860 100.  99  122  121.0 

1861 100.6  98  124  118.1 

1862 114.9  117.8             101  131  122.6 

1863 102.4  148.6             103  159  125.5 

1864 122.5  190.5             105  172  129.3 

1865 100.3  216.8              101  162  122.6 

1866 136.3  191.0             102  162  125.8 

1867 127.9  172.2             100  137  124.4 

1868 115.9  160.5              99  122  122.0 

1869 113.2  153.5              98  121  123.4 

1870 117.3  142.3              96  122  122.9 

1871 122.9  136.0             100  118  127.0 

1872 127.2  138.8             109  129  135.6 

1873 122.0  137.5             111  134  138.3 

1874 119.4  133.0             102  131  136.2 

1875 113.4  127.6              96  126  129.8 

1876 104.8  118.2              95  123  129.3 

1877 104.4  110.9              94  123  127.7 

1878 99.9  1015              87  116  120.6 

1879 96.6  96.$              83  100  117.1 

1880 106.9  88  115  121.9 

1881 105.7  85  108  121.0 

1882 108.5  84  111  122.1 

1883 106.0  82  106  122.2 

1884 99.4  76  101  114.2 

1885 93.0  72  95  108.7 

1886 91.9  69  92  104.0 

1887 92.6  68  94  102.0 

1888 94.2  70  101  102.0 

1889 94.2  72  99  106.1 

1890 92.3  112.9      72  102  108.1 

1891 92.2  111.7      72  101  109.2 

1892 87.6  106.1      68  97 

1893 87.2  105.6      68  96 

1894 79.3  96.1      63  95 

1895 77.2  93.6      62  87 

1896 74.6  90.4      61  91 

1897 74.0  89.7      62  88 

1898 77.1  93.4      64  86 

1899 83.9  101.7      68  87 

1900 91.2  110.5      75  97 

1901 88.5  108.5  70  97 

1902 93.2  112.9      69  89 

1903 93.7  113.6      69  91 

1904 935  113.0      70  100 

(American)  (American)  (English) 


106  MONEY  AND  BANKING 

133.  Foreign  price  tables. — The  index  numbers  given 
in  the  last  three  columns  of  the  table  are  reproduced 
from  the  most  important  foreign  investigations.  The 
Sauerbeck  and  Economist  tables  are  English,  the  Soet- 
beer  tables  are  German.  The  table  of  Mr.  Augustus 
Sauerbeck  was  published  in  the  Journal  of  the  Royal 
Statistical  Society.  His  indexes  are  computed  by  a 
simple  unweighted  arithmetical  average.  He  has  en- 
deavored to  arrange  a  limited  number  of  commodities, 
all  of  which  represent  raw  products,  in  classes  in  such 
a  way  as  to  be  equivalent  to  weighting. 

The  Economist  tables  have  the  distinction  of  being 
the  first  to  be  compiled.  Twenty-two  articles  only  are 
employed  in  this  table  and  the  quotations  are  those  of  a 
given  date,  either  the  first  of  January  or  the  first  of 
July  on  the  averages  for  the  year.  The  commodities 
are  chosen  disproportionately,  there  being  out  of  the 
twenty-two,  four  in  which  cotton  is  the  principal  ele- 
ment. 

The  German  table  of  Soetbeer  was  frequently  re- 
ferred to  in  the  Silver  Controversy  in  this  country  in 
1896.  The  number  of  commodities  was  over  three  hun- 
dred and  the  result  represents  the  simple  unweighted 
arithmetical  average  on  the  basis  of  the  years  1847  to 
1850. 

As  we  have  indicated  before,  the  value  of  the  study 
of  the  science  of  money  and  currency  is  the  understand- 
ing it  gives  us  of  the  significance  of  price  changes  and 
the  data  from  which  predictions  as  to  the  course  of  prices 
can  be  made.  It  is  therefore  important  to  get  clearly 
in  mind  the  main  points  of  the  two  preceding  chapters. 

In  the  first  place  a  general  rise  in  the  prices  of  all 
commodities  and  services  indicates  that  the  reason  is  to 
be  found  in  a  change  in  the  value  of  money  as  compared 


THEORY  OF  PRICES  107 

with  other  things,  since  we  know  that  a  general  rise  of 
values  is  an  impossibility.  The  rise  and  fall  of  general 
prices  is  best  indicated  by  means  of  price  tables  which 
correct  the  errors  which  a  limited  observation  would  be 
likely  to  incur.  The  most  convenient  and  acceptable 
price  table  for  the  average  business  man  is  that  pub- 
lished in  the  bulletins  of  the  Department  of  Labor.  A 
study  of  price  tables  will  give  the  student  an  idea  as  to 
the  stage  of  the  swing  at  which  the  observed  prices  are. 
134.  Economic  forces  to  be  observed. — Observing  the 
present  tendency  of  prices  he  will  endeavor  to  find  the 
reason  for  the  tendency.  He  will  find  almost  any  time 
a  number  of  reasons  to  account  for  a  rise  and  also  a 
number  of  reasons  to  account  for  a  fall.  This  makes  it 
necessary  for  him  to  estimate  quantitatively  the  potency 
of  each  one  of  these  forces  and  to  balance  one  against 
the  other,  in  order  to  discover  in  which  direction  the  re- 
sult of  these  forces  tends.  The  most  important  of  these 
permanent  forces  are  as  follows : 

1.  Production  of  gold. — At  the  present  time  it  will 
be  found  that  the  annual  production  of  gold  is  increas- 
ing.    This  in  itself  means  a  lower  value  for  gold  inas- 
much as  only  a  very  small  quantity  of  gold  that  is  once 
brought  into  existence  disappears.     Nearly  all  of  it  is 
added  to  the  stock  already  on  hand.     It  is  estimated  that 
only  about  20  per  cent  of  the  gold  annually  produced  is 
used  in  the  arts.    Even  this  amount  is  not  permanently 
withdrawn  from  monetary  uses,  since  it  is  so  easy  to  re- 
duce old  jewelry  and  plate  to  coin. 

2.  Use  of  substitutes  for  money. — An  increase  in  the 
supply  of  fiat  or  credit  money  has  the  same  effect  on 
prices  as  an  increase  in  the  supply  of  gold.     The  in- 
crease in  Government  issues  is  purely  an  arbitrary  mat- 
ter and  if  it  occurs  in  only  one  country  at  any  given 


108  MONEY  AND  BANKING 

time  it  is  likely  to  displace  the  proportionate  amount  of 
gold,  which  will  be  exported  from  the  country  as  a  re- 
sult of  the  effects  produced  upon  the  foreign  exchange 
market  by  a  rise  of  prices.  The  first  result  of  an  in- 
crease of  Government  paper  money  is  likely  to  be  a  rise 
of  prices,  but  after  the  equilibrium  is  established  in  the 
course  of  a  few  years,  other  things  being  equal,  the 
prices  are  likely  to  return  to  their  former  level. 

The  increase  in  the  amount  of  credit  which  serves  the 
purpose  of  a  medium  of  exchange  is  highly  important. 
This  medium  depends  upon  the  degree  of  perfection  to 
which  the  banking  machinery  of  a  community  has  been 
developed.  An  increase  in  the  number  of  banks  and 
trust  companies  and  in  the  capitalization  of  old  institu- 
tions indicate  increased  credit  facilities  which  are  equiva- 
lent to  an  increase  in  the  supply  of  the  medium  of  ex- 
change. For  short  periods  of  time  the  periodical  infla- 
tion and  deflation  of  credit,  producing  the  alternate 
booms  and  panics,  must  be  taken  into  account.  In  the 
year  1908  there  was  a  considerable  reduction  in  the 
amount  of  credit  over  the  year  1906,  while  the  number 
of  banks  and  the  amount  of  capitalization  actually  in- 
creased. The  total  bank  clearings  of  the  principal 
cities  of  the  United  States  are  a  much  better  index  of  the 
volume  of  credit  doing  money  work  than  the  number 
of  banks  or  their  capitalization. 

3.  Volume  of  production. — It  is  obvious  that  the 
greater  the  amount  of  goods  produced  the  greater  will 
be  the  number  of  bidders  for  money,  offering  goods  in 
exchange.  Under  modern  conditions  practically  all  the 
goods  produced  represent  a  demand  for  money,  as  they 
must  change  hands  before  they  are  consumed.  The 
producer  nowadays  very  rarely  consumes  his  own  prod- 
uct. 


THEORY  OF  PRICES  109 

An  increase  of  population  means  simply  an  increase 
in  the  amount  of  goods  produced  and  consumed  and 
means  a  greater  competition  for  the  existing  supply  of 
money. 

4.  Extravagant  expenditures  of  the  people. — During 
the  financial  difficulties  following  the  panic  of  1907  a 
great  deal  was  said  about  the  effect  of  the  growing  ex- 
travagance in  personal  expenditure  on  the  part  of  the 
people  of  this  country  during  the  preceding  four  or  five 
years.  This  was  held  by  some  to  be  the  cause  of  the 
stringency  of  the  money  market. 

Of  course  the  more  extensive  purchasing  by  the  peo- 
ple represents  an  addition  to  the  bidding  for  goods  and 
the  offering  of  money,  so  that  we  might  conclude  that  a 
rise  of  prices  would  be  the  result.  On  the  other  hand 
extravagant  expenditure  could  not  have  appeared  unless 
incomes  had  been  considerably  increased.  Increased  in- 
comes are  due  to  a  greater  productivity.  People  pro- 
duce more  goods  and  hence  have  a  larger  amount  to  sell 
before  they  can  realize  their  income.  This  enlarged 
production  of  goods  causes  a  bidding  for  money,  which 
counterbalances  the  enlarged  bidding  for  goods,  that 
follows  immediately  upon  it.  Thus  the  influence  upon 
prices  is  diminished. 

135.  Saving  and  investing. — If  instead  of  spending 
their  incomes  in  living  expenses  these  people  had  em- 
ployed them  in  any  other  way  except  hoarding — either 
depositing  them  in  banks  or  investing  them  in  securities 
the  producing  power  would  simply  have  changed  its 
form  and  instead  of  causing  a  bidding  up  of  prices  of 
consumption  goods  would  have  had  a  similar  effect  in 
connection  with  production  goods.  Money  deposited 
in  banks  or  invested  in  securities  is  simply  turned  over  to 
industrial  and  business  enterprises,  when  it  is  spent  for 


110  MONEY  AND  BANKING 

goods,  thus  having  the  same  effect  on  the  general  level  of 
prices. 

The  effect  of  the  expenditure  of  incomes  for  con- 
sumption goods  instead  of  for  production  goods  has  no 
immediate  effect  on  general  prices,  but  it  has  an  im- 
portant effect  upon  the  future  production  of  goods. 
Expended  upon  consumption  goods,  the  effect  is  to  di- 
minish the  supply  on  the  market  and  encourage  indus- 
trial activity  to  replace  them.  If  incomes  are  generally 
saved  and  invested  they  lead  to  a  considerable  enlarge- 
ment of  the  productive  capacity  of  industries  and  even- 
tually lead  to  an  increase  in  the  quantity  of  consumable 
goods  to  be  marketed  when  the  factories  and  machines 
and  equipment  begin  to  run  a  product. 

The  deductions  from  this  are  that  extravagant  per- 
sonal expenditures  tend  to  raise  prices  of  consumption 
goods  and  to  retard  future  over-production.  Saving 
and  investment  are  far  more  likely  to  be  the  immediate 
cause  of  a  panic  and  depression  on  account  of  the  larger 
quantity  of  goods  upon  the  market  after  the  production 
goods  have  been  installed  and  before  the  consuming  ca- 
pacity of  the  country  has  caught  up  with  the  productive 
capacity. 

A  much  more  reasonable  cause  for  a  panic  than  ex- 
travagant expenditure  is  to  be  found  in  the  unreasona- 
ble expansion  of  credit,  which  is  likely  to  be  brought 
about  by  rising  prices  and  larger  profits  which  induce 
men  to  undertake  productive  enterprises  far  in  excess  of 
the  present  consuming  power  of  the  people.  The  in- 
creased bidding  for  money  which  such  over-production 
brings  about  gives  the  impulse  to  a  cumulative  demand 
for  money  and  a  rapid  rise  in  its  value  compared  with 
other  things. 


THEORY  OF  PRICES  111 

The  rule  therefore,  upon  which  predictions  as  to  the 
future  course  of  prices  can  be  made  is  this : 

Do  existing  and  future  conditions,  taken  as  a  whole, 
warrant  the  conclusion  that  the  bidding  for  money  or 
the  offering  of  goods  will  be  stronger  than  the  offering 
of  money  and  the  bidding  for  goods? 


CHAPTER  IX 

DOMESTIC  AND  FOREIGN  EXCHANGE 

136.  Relation    between   foreign   and    domestic    ex- 
change.— In  a  preceding  chapter  mention  has  been  made 
of  the  process  by  which  the  gold  produced  in  any  part 
of  the  world  is  distributed  throughout  the  world.     In 
the  present  chapter  it  is  proposed  to  study  a  little  more 
closely  the  details  of  the  process  of  the  distribution  of 
money  and  the  methods  of  making  payments  between 
distant  points. 

The  subject  of  foreign  exchange  is  usually  regarded 
as  exceedingly  complex  and  technical.  The  reason  for 
this  is  that  some  of  the  fundamental  principles  are  but 
little  understood.  The  principles  of  foreign  exchange 
are  exactly  the  same  as  those  of  domestic  exchange,  the 
only  difference  being  that  there  is  in  foreign  exchange 
the  added  element  of  translation  from  one  coinage  basis 
to  another. 

137.  Payments  by  means  of  credit  balances. — The 
handling  of  actual  currency  in  transactions  of  any  size, 
even  though  the  currency  be  in  paper  notes  of  large 
denominations  and  the  transaction  takes  place  locally, 
is  inconvenient.     It  is  one  of  the  functions  of  banks  to 
obviate  the  necessity  of  making  payments  in  currency, 
by  means  of  a  checking  system.     The  whole  idea  of 
making  payments  and  settling  accounts  without  the  use 
of  cash  depends  upon  the  fact  that  under  certain  circum- 
stances a  creditor  is  just  as  willing  to  receive  in  payment 

112 


DOMESTIC  AND  FOREIGN  EXCHANGE        113 

the  right  to  demand  money  as  he  is  to  receive  the  cash 
itself.  In  cases  of  large  transactions  it  would  be  con- 
sidered a  great  hardship  on  the  part  of  the  recipient  of 
the  payment  to  be  required  to  accept  the  currency. 

138.  Function  of  the  bank  in  making  payments. — 
A  bank  is  an  institution  which  permits  persons  to  create 
credits  either  by  the  deposit  of  cash  or  by  borrowing  at 
the  market  rate  of  interest.     Furthermore  it  permits 
these  creditors  to  draw  orders  upon  it  for  any  amount 
up  to  the  limit  of  their  credit.     These  orders  or  checks 
give  the  holder  the  right  to  demand  the  cash  or  to  create 
credit  for  himself  by  a  deposit  of  the  checks.     These 
credits  on  the  books  of  the  banks  in  favor  of  their  pa- 
trons furnish  a  means  of  payment  which  has  almost 
superseded  the  use  of  cash  in  transactions  of  any  size. 
If  there  were  only  one  bank  in  a  town  all  the  checks 
drawn  against  it  would  return  to  it,  either  for  payment 
or  deposit.     If  there  are  several  banks  in  the  city  some 
sort  of  clearing  system  is  required  for  settling  the  debit 
and  credit  balances  among  the  different  institutions. 

139.  Payments  at  a  distance. — When  payments  are 
to  be  made  between  distant  localities  the  matter  of  dis- 
tance increases  the  complexity  of  making  the  settle- 
ments, but  the  principles  remain  the  same.     If  a  busi- 
ness man  in  Chicago  wishes  to  pay  a  bill  in  Cincinnati 
he  will  probably  draw  a  check  on  his  local  bank  exactly 
as  though  his  creditor  did  business  in  the  same  city. 
The  Cincinnati  man  will  deposit  the  check  in  his  local 
bank  and  put  upon  it  the  burden  of  making  the  col- 
lection.    When  the  banking  system  of  the  country  was 
not  so  well  organized  as  at  present  the  charge  for  making 
collections  of  local  checks  was  so  heavy  that  the  creditors 
frequently  refused  to  take  local  checks.     Under  these 
circumstances  the  debtor  was  obliged  to  apply  to  his 

VII— 8 


MONEY  AND  BANKING 

bank  for  a  draft  which  would  be  acceptable  in  the  city 
where  the  amount  was  payable. 

The  fact  that  New  York  is  the  commercial  and  finan- 
cial center  of  the  United  States  and  that  business  men  in 
every  city  and  town  are  likely  to  have  financial  relations 
with  that  city,  either  purchasing  goods  from  it  or  selling 
goods  to  it,  has  made  it  advisable  for  banks  throughout 
the  country  to  maintain  deposits  in  banks  of  that  city. 
Thus  it  happens  that  there  are  always  payments  to  be 
made  in  New  York  by  merchants  buying  there  and  pay- 
ments to  be  made  from  that  city  by  merchants  selling 
there. 

140.  Exchange  on  New  York. — Without  the  use  of 
exchange  it  would  be  necessary  to  pay  for  every  ship- 
ment of  goods  by  forwarding  cash  and  to  receive  pay- 
ment for  every  consignment  by  transporting  cash  in  the 
opposite  direction.  With  the  use  of  credit  the  shipper 
in  the  inland  town  receives  payment  for  his  consignment 
by  either  drawing  a  draft  upon  the  consignee  or  await- 
ing the  receipt  of  a  draft  upon  a  New  York  bank. 
Either  of  these  instruments  he  deposits  in  his  local 
bank  which  forwards  it  to  New  York  and  receives  a 
credit  there  upon  the  books  of  the  bank  against  which 
it  was  drawn.  The  bank  has  then  the  right  to  receive 
a  certain  sum  of  money  in  New  York  and  can  realize 
upon  this  right  either  by  requesting  the  shipment  of  cash 
or  by  drawing  a  draft  against  it. 

Merchants  who  have  made  purchases  from  New  York 
must  provide  a  means  of  payment  in  New  York  when 
the  bills  are  due.  The  local  banks  having  deposits  in 
New  York  are  quite  willing  to  sell  orders  upon  the  New 
York  bank.  Thus  by  means  of  buying  and  selling  the 
right  to  sums  of  money  in  New  York  the  payments 


DOMESTIC  AND  FOREIGN  EXCHANGE       115 

which  are  necessitated  by  the  movement  of  goods  in  and 
out  are  made. 

141.  How  the  banks  handle  New  York  exchange. — 
New  York  exchange  or  orders  upon  deposits  in  New 
York  hanks  are  acceptable  everywhere ;  in  the  first  place, 
because  there  are  so  many  persons  wishing  to  make  pay- 
ments in  that  city,  and  in  the  second  place  because  every 
banking  institution  in  the  country  deals  either  directly 
or  indirectly  with  some  New  York  bank. 

How  the  local  banks  get  their  power  to  sell  drafts  on  New 
York  can  best  be  shown  by  a  concrete  illustration.  We  will 
suppose  that  a  bank  in  Aurora,  Illinois,  has  on  deposit  $10,000 
with  the  First  National  of  Chicago.  Let  us  suppose  that  an 
Aurora  manufacturer  has  sold  stoves  to  an  eastern  dealer  and 
has  received  in  payment  a  check  for  $1,000  on  the  Corn  Ex- 
change bank  of  New  York.  He  will  deposit  this  check  in  his 
Aurora  bank,  which  will  send  it  to  its  Chicago  correspondent, 
and  thereby  increase  its  credit  balance  to  $11,000.  The  Chicago 
bank  will  send  the  check  to  its  correspondent  in  New  York,  and 
so  increase  its  credit  balance  in  New  York  by  $1,000.  By  an 
arrangement  with  the  First  National  Bank  of  Chicago  the 
Aurora  bank  is  able  to  sell  drafts  on  the  Corn  Exchange  of 
New  York,  using  for  the  purpose  blank  drafts  furnished  by  the 
First  National.  It  is  quite  possible  that  on  the  same  day  a 
merchant  in  Aurora,  who  has  bought  goods  from  New  York, 
will  call  upon  the  Aurora  bank  for  a  draft  on  New  York.  He 
may  not  want  a  draft  for  exactly  $1,000,  but  that  does  not  mat- 
ter. The  Aurora  bank  is  able  to  sell  him  a  draft  to  any  amount 
up  to  $11,000,  for  its  credit  balance  in  the  Chicago  bank  gives 
it  a  right  to  "draw"  upon  New  York  for  that  amount.  Thus, 
on  account  of  New  York's  trade  relations  with  all  parts  of  the 
country,  banks  everywhere  are  usually  able  to  sell  drafts  on  that 
city  without  being  compelled  to  ship  currency. 

New  York  exchange  is  used  not  only  for  payments  between 


116  MONEY  AND  BANKING 

New  York  and  other  parts  of  the  country  but  also  for  payments 
between  points  in  the  United  States  outside  of  New  York.  A 
man  living  in  Buffalo  who  owes  $1,000  to  a  man  in  New  Or- 
leans can  best  pay  the  debt  by  remitting  a  draft  on  New  York 
City.  This  method  is  the  one  usually  employed,  for  Buffalo 
banks  maintain  no  balances  in  New  Orleans,  and  so  cannot  sell 
drafts  on  that  city.  They  can,  however,  sell  a  draft  on  New 
York,  and  that  will  usually  be  accepted  by  New  Orleans  banks 
at  par.  When  the  reader  takes  into  account  that  New  York 
checks  and  drafts  are  every  day  being  used  in  this  way  for  the 
cancellation  of  debts  in  all  parts  of  the  United  States,  he  will 
understand  why  New  York  exchange  is  deservedly  called  the 
"business  man's  money." 

142.  Settlement  of  accounts  between  banks. — While 
in  the  long  run  the  movement  of  goods  from  New  York 
and  to  New  York  must  practically  balance,  yet  it  would 
be  a  rare  coincidence  if  the  commodities  sent  from  any 
given  locality  to  New  York  exactly  balance  the  goods 
received  from  that  city.  Any  particular  bank,  there- 
fore, has  occasion  to  purchase  more  New  York  exchange 
than  it  needs  to  sell,  or  it  has  a  demand  for  more  than 
it  has  occasion  to  buy  or  receive  on  deposit  from  its  cus- 
tomers. Unless  the  country  bank  wishes  to  shift  its 
deposit  account  from  a  New  York  bank  to  some  other 
bank  it  must  make  a  shipment  of  currency  if  it  wishes 
to  reduce  its  deposit. 

In  case  a  country  bank  has  a  deposit  with  its  New 
York  correspondent  which  it  considers  large  enough  it 
will  accept  deposits  of  checks  on  New  York  only  with 
the  intention  of  making  shipments  of  cash  to  reimburse 
itself  for  the  sums  paid  out.  The  shipment  of  currency 
involves  expense  and  it  is  quite  likely  that  it  will  not 
accept  superfluous  New  York  exchange  unless  it  re- 

i  Johnson,  "  Money  and  Currency,"  pp.  79-80. 


DOMESTIC  AND  FOREIGN  EXCHANGE        117 

ceives  a  fee  which  will  cover  the  cost  of  collecting  the 
same  in  cash.  This  cost  depends  upon  three  items :  first 
the  express  charge,  second  insurance,  and  third  the  loss 
of  interest.  The  charge  for  transportation  is  usually 
combined  with  the  charge  for  insurance  by  the  express 
company.  The  moment  the  New  York  bank  delivers 
the  cash  to  the  express  company  for  shipment  to  the 
country  bank  upon  its  order  it  ceases  to  pay  interest 
upon  that  sum.  The  country  bank  therefore  loses  the 
interest  upon  the  same  until  it  receives  it  and  uses  it  as 
a  basis  for  interest  paying  loans. 

143.  Cost  of  currency  shipments. — The  cost  of  cur- 
rency shipments  between  New  York  and  Chicago  is  in 
the  neighborhood  of  50  cents  per  thousand  dollars;  be- 
tween St.  Louis  and  New  York  it  is  60  cents;  between 
New  Orleans  and  New  York  it  is  75  cents,  and  between 
San  Francisco  and  New  York  it  is  $1.50. 

144.  Settlements   through    the   sub-treasuries. — The 
cost  of  shipping  currency  from  one  city  to  the  other  is 
frequently  saved  to  the  banks  by  the  Treasury  Depart- 
ment of  the  Government.     For  a  good  many  years  pay- 
ments to  be  made  between  the  Treasury  at  Washington 
and  the  sub-treasuries  in  the  various  large  cities  were 
all  conducted  by  cash  shipments.     It  happened  very  fre- 
quently that  at  the  same  time  that  the  treasury  was  for- 
warding considerable  sums  of  cash  between  two  cities, 
the  banks  would  be  shipping  currency  in  the  opposite 
direction.     An  ingenious  cashier  in  New  Orleans  early 
in  the  seventies  suggested  to  the  Secretary  of  the  Treas- 
ury, McCullough,  that  a  saving  both  to  the  Government 
and  the  banks  might  be  effected  if  the  banks  when  they 
wished  to  transmit  money  to  a  city  in  which  a  sub- 
treasury  was  located  would  ascertain  whether  the  Gov- 
ernment at  the  same  time  did  not  wish  to  send  money  in 


118  MONEY  AND  BANKING 

the  opposite  direction.  If  this  proved  to  be  the  case  it 
would  be  profitable  to  the  banks  and  to  the  Government 
to  allow  the  banks  to  deposit  the  money  in  the  Treasury 
and  receive  an  order  upon  the  Treasury  in  the  other  city. 
The  Treasury  office  in  the  first  city  would  receive  the 
currency  it  required  from  the  depositing  bank  and  the 
bank  in  the  other  city  would  receive  the  currency  from 
the  Treasury  instead  of  from  its  correspondent  and  all 
cost  of  transporting  the  money  would  be  eliminated. 

145.  Rate  of  New  York  exchange. — Suppose  there 
was  a  great  demand  for  New  York  exchange  in  any 
city  on  account  of  the  heavy  bills  of  merchandise  falling 
due  at  some  particular  season  of  the  year.  The  banks 
will  discover  that  the  demand  for  New  York  exchange 
far  exceeds  the  supply  of  checks  and  drafts  deposited 
by  customers.  Their  deposits  with  their  New  York  cor- 
respondents are  reduced  and  in  order  to  continue  sell- 
ing New  York  exchange  they  must  ship  currency  to 
that  city.  In  that  case  they  will  be  justified  in  charg- 
ing at  least  50  cents  premium  for  every  $1,000 
of  New  York  exchange  sold  in  order  to  reimburse 
themselves  for  the  actual  cost.  Competition  between 
the  local  banks  will  not  permit  a  much  higher  charge 
than  this. 

On  the  other  hand  if  the  receipts  of  New  York  ex- 
change exceed  the  demand  for  it,  on  account  of  heavy 
shipments  of  grain  or  produce  to  the  chief  exporting 
city  of  the  country,  the  banks  will  find  their  deposits  in 
New  York  larger  than  they  care  to  maintain.  They 
will  be  forced  to  order  shipments  of  currency  to  them. 
To  reimburse  themselves  for  the  expense  they  will  sub- 
tract from  the  face  value  of  the  exchange  bought  or 
received  on  deposit,  the  cost  of  doing  the  business. 
Thus  it  is  possible  for  exchange  on  New  York  in  San 


DOMESTIC  AND  FOREIGN  EXCHANGE        110 

Francisco  to  be  sold  at  a  premium  of  $1.50  or  to  be 
offered  at  a  discount  of  the  same  amount. 

146.  Significance  of  rates  of  domestic  exchange. — 
The  premium  or  discount  on  domestic  exchange  is  pub- 
lished in  the  principal  dailies  and  is  useful  to  the  busi- 
ness man  as  indicating  the  volume  and  direction  of  trade 
at  any  particular  time.  An  unusually  high  premium  on 
New  York  exchange  or  an  unusually  prolonged  pre- 
mium will  indicate  that  the  purchases  of  local  merchants 
has  been  unusually  heavy  in  that  year  if  there  are  no 
unusual  transactions  to  affect  the  price  of  exchange. 

Why  does  it  not  happen  that  under  certain  circum- 
stances a  community  may  buy  more  goods  than  it  sells 
during  any  particular  period  and  thus  be  forced  to  part 
with  all  of  its  currency  in  settling  the  balance?  Since 
each  trader  is  simply  looking  out  for  his  own  private 
profit  and  does  not  concern  himself  with  the  question 
of  the  amount  of  currency  there  seems  to  be  no  reason 
why  a  community  might  not  be  drained  of  its  currency. 
This  brings  up  the  question  of  the  balance  of  trade,  the 
principles  of  which  are  the  same  whether  the  exchange 
of  goods  is  between  two  separate  nations  or  between  two 
localities  within  the  same  nation. 

Suppose  for  any  reason  that  there  should  be  an  un- 
usually heavy  purchasing  of  goods  by  the  merchants  of 
a  western  State  in  any  particular  year.  The  merchants 
would  buy  from  the  banks  New  York  exchange  with 
which  to  pay  their  bills.  The  banks,  after  having  ex- 
hausted their  credits  in  New  York  would  be  obliged  to 
ship  currency  in  order  to  cover  the  drafts  on  New 
York  sold  to  the  merchants. 

There  is  never  any  danger  that  a  community  will  be  stripped 
of  its  money  or  cash  as  a  result  of  its  purchases  of  goods  from 


120  MONEY  AND  BANKING 

other  communities.  No  matter  how  freely  Chicago  and  the 
country  tributary  to  it  may  purchase  goods  from  the  East, 
those  purchases  can  never  make  any  serious  drain  upon  the  cash 
supply  of  Chicago.  No  matter  how  extravagant  the  people  of 
the  West  may  be,  their  purchases  of  eastern  goods  can  never 
be  greatly  in  excess  of  their  sales  to  eastern  customers.  Should 
the  people  of  Chicago  for  extraordinary  reasons  at  any  time  in- 
crease their  purchases  from  New  York  and  other  eastern  cities, 
the  first  effect  in  Chicago  would  be  an  increase  in  the  demand  for 
New  York  exchange  and  in  bank  shipments  of  currency  from 
Chicago  to  New  York.  The  loss  of  currency  in  Chicago,  since 
it  would  reduce  the  lending  power  of  Chicago  banks,  would  tend 
to  cause  a  rise  in  the  rate  of  interest  and  a  rise  in  the  value  of 
money.  The  prices  of  commodities  named  would  begin  to  de- 
cline; not  of  all  commodities,  but  of  those  which  are  subjects  of 
speculation,  such  as  stocks,  wheat,  corn  and  pork.  Most  of  the 
speculators  in  these  articles  are  borrowers,  and  the  interest  they 
pay  is  an  important  item  in  the  expenses  of  their  business,  so 
that  when  the  interest  rate  rises  they  are  obliged  to  contract 
their  operations.  Chicago  would  thus  become  a  good  place  to 
lend  in  and  also  a  good  place  in  which  to  buy  stocks  and  bonds, 
wheat,  and  other  speculative  commodities.  In  other  words,  the 
value  of  money  would  rise  in  Chicago,  and  people  in  other  parts 
of  the  country  would  increase  their  purchases  in  Chicago  mar- 
kets, remitting  New  York  exchange  in  payment.  The  reader 
must  not  suppose  that  those  changes  in  price  or  in  the  rate  of 
interest  heed  be  so  great  as  to  attract  general  attention.  Never- 
theless it  cannot  be  doubted  that  such  changes  do  take  place,  and 
that  as  a  result  the  sales  of  Chicago  to  other  parts  of  the  coun- 
try are  so  adjusted  that  in  the  long  run  they  furnish  a  supply  of 
New  York  exchange  equal  to  the  demand. 

Thus  it  happens  throughout  the  country  that  in  the  course 
of  a  year  the  debts  of  every  community  are  always  practically 
balanced  by  its  credits  on  account  of  sales,  so  that  large  ship- 
ments of  currency  are  never  necessary.  Indeed,  if  our  monetary 
and  banking  systems  were  perfect,  no  shipment  of  currency  from 


DOMESTIC  AND  FOREIGN  EXCHANGE 

one  part  of  the  country  to  another  would  ever  occur  as  a  neces- 
sary result  of  trade  transactions.  Money  or  currency  would 
only  be  shipped  to  a  community  as  a  result  of  an  increasing  need 
for  it  as  a  medium  of  exchange  or  as  a  basis  for  the  expansion 
of  bank  credits.  In  Canada,  for  example,  on  account  of  the 
elasticity  of  its  bank-note  circulation,  seasonal  variations  in  the 
demand  for  currency  are  easily  provided  for  by  the  local  banks 
and  their  branches.1 

147.  The  clearing  house  principle. — Domestic  ex- 
change as  we  have  seen,  is  simply  a  banking  device  to 
avoid  the  unnecessary  shipment  of  money  by  settling  bal- 
ances only.  The  principle  is  exactly  the  same  as  that 
on  which  clearing  houses  are  based.  The  banks  in  any 
one  city  find  at  the  end  of  the  day  that  they  have  re- 
ceived from  their  depositors  a  great  number  of  checks 
drawn  on  neighboring  banks.  Before  the  days  of  the 
clearing  house  each  bank  sent  a  messenger  to  all  the 
others  with  the  items  against  them  and  received  the  cash 
in  payment.  At  the  same  time  that  each  of  the  banks 
were  sending  out  messengers  to  make  collections  they 
were  paying  cash  over  the  counter  to  the  messengers 
of  other  banks  in  settlement  of  the  checks  against  them. 
By  having  a  common  place  of  meeting  the  messengers 
could  deliver  the  items  to  the  debtor  banks  and  could 
receive  the  checks  representing  the  credits  due  them  all 
at  one  time  and  could  easily  figure  up  the  difference  be- 
tween the  debits  and  the  credits.  Settlement  could  then 
be  made  by  payments  representing  the  differences  which 
were  likely  to  be  less  than  10  per  cent  of  the  total  trans- 
action, thus  saving  the  handling  of  90  per  cent  of  the 
cash  represented  by  the  checks  handled. 

The  clearing  house  principle  has  not  yet  been  applied 
to  its  fullest  extent  in  the  settling  of  accounts  between 

i  Johnson,  M  Money  and  Currency,"  pp.  83-84. 


133  MONEY  AND  BANKING 

banks  in  different  localities.  The  forwarding  of  the 
checks  to  a  central  point,  together  with  other  difficulties 
which  will  be  discussed  later,  has  up  to  this  time  made 
the  establishment  of  a  clearing  institution  for  out  of 
town  collections  an  impossibility.  The  same  result, 
however,  is  accomplished  by  the  custom  of  country 
banks  keeping  balances  in  the  city  banks  and  drawing 
against  such  accounts  instead  of  shipping  currency. 

148.  Settling  balances  by  use  of  credit. — Methods 
have  been  found  for  eliminating  the  shipment  of  cur- 
rency, even  in  order  to  pay  balances.     Banks  which  be- 
come   debtors    to    others   through   the    settlement    of 
accounts  may  borrow  the  balance  due  from  the  creditor 
bank  and  pay  interest  thereon.     This  of  course  is  not  a 
final  settlement  of  the  balance,  but  simply  postpones  the 
settlement,  yet  if  in  the  near  future  the  balance  happens 
to  run  in  the  opposite  direction  the  loan  may  be  liqui- 
dated by  a  credit  balance  instead  of  by  the  payment  of 
cash. 

149.  Gold  the  international  medium. — In  the  case  of 
domestic  exchange  ultimate  payments  may  be  made  in 
any  form  of  currency  but  in  the  settlement  of  balances 
between  different  nations  gold  is  the  only  acceptable 
medium.     Since  gold  is  the  ultimate  basis  of  credit  in 
all  civilized  countries,  and  since  a  volume  of  currency 
from  six  to  ten  times  its  amount  is  erected  upon  it,  the 
movements  of  gold  from  one  place  to  another  are  of 
vastly  more  importance  than  movements  of  any  other 
form  of  cash.     Exports  and  imports  of  gold  in  and  out 
of  a  country  are  likely  to  disturb  the  money  situation  and 
to  necessitate  frequent  readjustments  of  credit  condi- 
tions at  new  rates  of  interest.     The  movements  of  gold 
are  the  result  of  foreign  exchange  operations,  and  it  is 


DOMESTIC  AND  FOREIGN  EXCHANGE        123 

this  fact  which  causes  business  men  to  scrutinize  so 
carefully  daily  quotations  for  foreign  exchange. 

150.  Function  of  the  dealer  in  foreign  exchange. — 
The  service  to  the  business  community  of  the  interna- 
tional banker  who  deals  in  foreign  exchange  is  not  only 
that  he  does  away  with  over  90  per  cent  of  the  shipments 
of  gold  which  would  otherwise  be  necessary,  and  thus 
causes  a  great  saving  of  expense  and  risk  in  settling 
commercial  transactions,  but  of  far  greater  importance 
is  the  service  that  he  renders  in  steadying  the  credit  con- 
ditions the  world  over.     His  function  is  more  than  to 
eliminate  the  shipments  of  money  back  and  forth  to 
make  payments — he  still  further  decreases  such  ship- 
ments by  borrowing  and  lending  in  foreign  markets, 
so  that  the  final  and  absolutely  necessary  shipments  of 
gold  are  reduced  to  a  very  low  minimum  as  compared 
to  the  total  amount  of  business  transacted. 

151.  Example  of  foreign  exchange. — Let  us  take  a 
typical  case  in  foreign  commerce  and  show  how  the  in- 
ternational banker  facilitates  the  transaction.     Armour 
&  Company  receive  an  order  from  a  British  dealer  in 
meats  for  a  shipment  of  beef.     After  the  beef  has  been 
loaded  on  the  cars  Armour  &  Company  draw  a  draft  on 
the  English  consignee  which  in  effect  requests  him  to 
pay  to  the  Chicago  National  Bank  or  anybody  else 
designated   by    them,    the    sum   of    .£1,000    sterling. 
Armour   &    Company   might    have   waited   until   the 
English  customer  had  received  the  meat  and  remitted 
to  them  a  check  which  Armour  &  Company  could  have 
collected  through  their  bank.     If  this  were  the  custom 
Armour  &  Company  would  be  required  to  tie  up  an 
enormous  amount  of  capital  in  this  export  business.     It 
is  the  almost  universal  practice  of  British  business  men, 


124  MONEY  AND  BANKING 

however,  to  draw  upon  their  customers  for  the  amount 
of  goods  sold  as  soon  as  they  are  shipped  and  the 
American  exporters  find  this  very  advantageous  because 
they  can  realize  the  proceeds  of  a  sale  of  goods  very 
quickly  and  it  relieves  them  from  the  necessity  of  bor- 
rowing so  much  working  capital. 

The  Chicago  National  Bank  is  willing  to  purchase 
or  give  credit  to  Armour  &  Company  for  the  draft  im- 
mediately, although  it  cannot  reimburse  itself  for  sev- 
eral weeks  unless  it  sells  the  draft  outright  to  another 
bank,  in  which  case  it  simply  shifts  the  burden  to  the 
other  bank.  It  is  the  business  of  a  bank  to  provide  com- 
merce with  working  capital  for  a  consideration;  in  this 
case  the  consideration  comes  to  them  in  the  form  of  a 
discount  which  they  deduct  from  the  face  of  the  draft 
in  purchasing  from  Armour  &  Company. 

152.  Why  bankers  are  willing  to  purchase  foreign 
drafts. — The  bankers  are  willing  to  purchase  the  draft, 
even  though  they  have  never  heard  of  the  English  firm 
on  whom  it  is  drawn,  for  the  following  reasons:  (1) 
The  reputation  of  Armour  &  Company  assures  them 
that  the  draft  would  not  be  drawn  unless  a  shipment 
of  merchandise  had  been  made.  (2)  Armour  &  Com- 
pany as  drawers  of  the  draft  under  the  universal  law 
of  negotiable  instruments,  endorse  the  payment  of  the 
same  and  may  be  held  for  payment  if  the  English 
drawee  fails  to  accept  it.  (3)  In  most  cases  there  is 
attached  to  the  draft  a  negotiable  bill  of  lading  which 
vests  the  right  to  receive  the  goods  in  the  possessor  of 
the  bill  of  lading.  The  English  bank  to  whom  they 
have  assigned  the  draft  will  not  deliver  the  bill  of 
lading  until  the  consignee  has  accepted  or  paid  the 
draft.  (4)  To  still  further  guarantee  the  banks 
against  loss  there  is  attached  to  the  draft  beside  the  bill 


DOMESTIC  AND  FOREIGN  EXCHANGE        125 

of  lading  an  insurance  policy  which  entitles  the  banker 
to  receive  reimbursement  if  the  consignment  should  be 
damaged  or  lost  in  transit.  There  may  also  be  attached 
to  the  draft  certificates  of  Government  inspection  certi- 
fying the  quality  of  the  meat  and  also  an  invoice  of  the 
shipment. 

153.  Progress  of  draft. — These  safeguards  are  so 
effective  in  guaranteeing  payment  of  the  draft  that  it 
is  extremely  rare  that  even  a  dispute  occurs  in  trans- 
actions of  this  kind.     The  Chicago  National  Bank,  if 
it  has  no  correspondent  in  England,  may  sell  the  draft 
in  New  York.     The  New  York  bank  will  send  the  draft 
to  England  for  collection  and  credit  the  same  to  its  ac- 
count.    New  York  banks  are  always  willing  to  purchase 
these  foreign  drafts  and  to  create  credits  abroad  in 
order  to  be  in  a  position  to  sell  foreign  exchange  to 
importers  and  others  who  are  required  to  make  pay- 
ments abroad.     The  foreign  trade  of  this  country  is 
so  large  that  there  is  always  a  demand  as  well  as  a  sup- 
ply of  foreign  exchange.     The  international  banker  who 
deals  in  it  is  exactly  like  a  merchant  who  buys  and  sells 
any  commodity. 

154.  Quotations  for  foreign  exchange. — The  quota- 
tions for  sterling  exchange  are  the  prices  at  which  the 
right  to  receive  certain  sums  in  England  is  bought  and 
sold  in  New  York  and  varies  like  everything  else  ac- 
cording to  demand  and  supply. 

155.  The  pound  sterling. — The   monetary  unit  of 
England  is  the  pound  sterling,   which  contains   118 
grains  of  pure  gold.     Since  our  monetary  unit  is  the 
dollar,  composed  of  23.22  grains  of  gold,  it  is  easy  to 
calculate  that  the  English  sovereign,  which  is  the  name 
of  the  coin  containing  a  pound  sterling,  is  exactly  equiv- 
alent to  $4.8665.     In  other  words  an  English  sovereign 


126  MONEY  AND  BANKING 

can  be  taken  to  a  United  States  mint  and  recoined  into 
4.8665  American  gold  dollars. 

There  is  a  great  difference,  however,  between  the 
right  to  receive  gold  sovereigns  in  England  and  the 
possession  of  gold  sovereigns  in  the  United  States. 
A  gold  sovereign  in  England  will  not  pay  a  debt  in 
America  unless  it  is  first  imported  into  this  country  and 
coined  into  legal  tender.  Therefore  it  is  worth  to  its 
American  owner  $4.8665,  less  the  cost  of  bringing  it  to 
this  country,  unless  he  can  realize  upon  it  by  selling  the 
right  to  receive  it  in  England  to  some  one  who  wishes 
to  use  it  there. 

156.  Cost  of  shipping  gold. — The  cost  of  shipping  gold 
across  the  Atlantic  varies  slightly  from  time  to  time.  The  fol- 
lowing figures,  showing  the  cost  of  shipping  $1,000,000  in  gold 
from  New  York  to  London  were  furnished  by  the  representative 
of  one  of  the  largest  New  York  banking  houses : 

Invested  in  fine  bars,  23,220,000  gr $1,000,000 

Assay  office  premium  on  bars  4  cents  per  $100 .  .,.  .  400 

Freight  5-32  per  cent 1,562 

Insurance  1-16  per  cent 625.50 

Packing  and  cartage.  . 70 


$1,002,657.50 

The  Bank  of  England's  price  of  gold  varies  77s.  9^2^.  to 
77s.  Wy2d.  per  ounce,  English  standard,  913  3-3  fine.  The 
mint  coins  an  ounce  of  gold,  English  standard,  into  77s.  lO^d. ; 
but  the  Bank  of  England,  with  which  it  is  the  custom  of  the 
bullion  brokers  to  deal,  usually  pays  a  fraction  less  than  this 
sum,  thus  saving  itself  from  loss  of  interest  while  the  bullion  is 
being  coined.  It  is  assumed  below  that  the  Bank  pays  77s.  lOd. 
per  ounce: 

48,375  oz.  fine  equal  52,772.7  oz.  916  2-3  fine, 


DOMESTIC  AND  FOREIGN  EXCHANGE        127 

52,772.7  oz.  at  77s.  lOd £205,374 

Deduct  sundry  expenses , 4 


Net  receipts  in  London £205,370 

Cost  of  sovereign  (1,002,675.5 -:- 205,370) $4.8822 

Mint  par  in  the  United  States 4.8665 


Cost  of  shipment  per  sovereign .$  .0157 

No  loss  of  interest  is  included  in  the  foregoing.  The  New 
York  banker  who  furnished  the  figures  held  that  no  such  item 
was  involved,  for  he  sold  sterling  exchange  as  soon  as  he  made 
shipment  and  so  was  never  out  his  money  in  consequence.  If  we 
include  interest,  we  raise  the  cost  of  shipment  to  $.0197  per  sov- 
ereign.1 

157.  The  minimum  gold  point  for  sterling  exchange. 
— Calculating  the  total  cost  of  shipping  gold  between 
America  and  Europe  at  the  lowest  figure  of  two  cents 
per  pound  sterling,  it  is  easy  to  understand  why  $4.8465 
is  called  the  minimum  gold  point  for  foreign  exchange. 
If  there  should  be  an  extraordinary  supply  of  foreign 
bills  for  sale  their  price  under  normal  conditions  could 
never  go  far  below  this  figure  because  there  would  al- 
ways be  some  international  banker  who  would  be  willing 
to  pay  for  them  the  moment  there  was  any  profit  in 
buying  them,  for  the  purpose  of  exporting  the  gold, 
after  they  had  been  cashed  in  England.     This  mini- 
mum price  does  not  mean  that  the  value  of  foreign  bills 
is  an  exception  to  the  law  of  supply  and  demand,  but 
that  when  the  price  falls  below  a  certain  minimum  there 
arises  automatically  an  unlimited  demand. 

158.  Maximum  gold  point  for  sterling  exchange. — 

i  Johnson,  "  Monejr  and  Currency," 


128  MONEY  AND  BANKING 

On  the  other  hand  the  price  of  sterling  bills  may  not 
rise  above  $4.8865  under  normal  conditions  because  at 
that  figure  there  is  always  an  unlimited  supply,  so  that 
no  one  who  wishes  to  buy  need  pay  any  more.  The 
reason  for  this  unlimited  supply  is  this:  The  interna- 
tional bankers,  seeing  a  chance  for  profit,  will  sell 
foreign  exchange  above  the  maximum  gold  point 
whether  or  not  they  have  a  credit  balance  abroad. 
Lacking  such  a  balance,  they  buy  gold  with  the  proceeds 
of  the  bills.  As  soon  as  they  have  been  issued  they  ex- 
port gold  to  Europe  so  that  it  will  arrive  at  the  same 
time  the  bills  are  presented  for  payment,  thus  closing 
the  transaction  as  far  as  the  issuer  of  the  bills  is  con- 
cerned. 

159.  Why  sterling  exchange  may  fall  below  $4.8465. 
— We  have  seen  that  theoretically  the  price  of  demand 
sterling  cannot  fall  much  below  $4.8465  because  of  the 
great  demand  on  the  part  of  the  bankers  when  it  tends 
to  fall  below.  There  are  conditions,  however,  under 
which  the  price  may  fall  considerably  lower  without  call- 
ing into  existence  this  demand.  In  March,  1907,  the 
price  fell  to  $4.83  for  a  time,  and  in  the  autumn  it  fell 
still  lower.  There  were  several  reasons  for  this. 

(1)  The  rate  for  call  loans  in  New  York  was  very 
high  and  the  bankers  who  would  otherwise  have  pur- 
chased the  exchange  did  not  do  so  because  it  was  more 
profitable  to  loan  the  money  than  to  invest  it  in  the 
exchange  which  would  have  tied  it  up  for  at  least  two 
weeks,  the  time  required  to  send  the  bills  to  London, 
exchange  them  for  gold,  and  ship  the  gold  to  this 
country. 

(2)  The  reluctance  of  the  American  bankers  to  with- 
draw gold  from  England  at  a  time  when  it  was  needed 
there  and  when  there  was  danger  of  a  rise  in  the  dis- 


DOMESTIC  AND  FOREIGN  EXCHANGE       129 

count  rate  if  the  reserve  in  the  Bank  of  England  were 
endangered. 

(3)  The  difficulty  in  getting  gold  for  export.     The 
bills  could  be  paid  in  notes  and  although  the  Bank  of 
England  must  redeem  all  notes  when  asked  to  do  so, 
they  have  the  right  to  pay  out  coins  of  less  than  full 
weight  and  make  a  difference  of  a  cent  in  the  £  in  the 
profit  of  the  exporter. 

(4)  The  high  price  of  gold  bullion  in  London.     To 
avoid  the  loss  incidental  to  shipping  coins,  the  abrasion 
and  the  light  weight,  bars  of  gold  must  be  purchased 
in  the  market.     Gold  bullion  is  marketed  in  London  as 
a  commodity  but  with  fixed  limits  to  fluctuation  of  price. 

(5)  The  premium  on  currency  in  New  York  in  No- 
vember, 1907,  due  to  the  suspension  of  cash  payments  by 
the  banks. 

160.  The  gold  market. — The  bulk  of  the  gold  pro- 
duced in  the  world  comes  from  South  Africa  direct  to 
London  to  the  amount  of  about  $2,500,000  per  week. 
The  bullion  brokers  meet  on  Mondays  to  trade.  Some 
of  them  have  certain  amounts  of  bullion  to  dispose  of; 
others  have  buying  orders.  They  begin  by  comparing 
notes  and  quite  a  variety  of  interesting  situations  may 
be  disclosed.  There  may  be  a  big  amount  to  offer  and 
a  few  small  buyers,  or  vice  versa.  At  present  there  is 
a  keen  competition  for  the  gold. 

The  Bank  of  England  is  required  to  pay  out  notes 
for  gold  (to  buy  gold)  at  the  rate  of  77s  9d  per  ounce 
and  this  fixes  the  minimum  price.  On  the  other  hand, 
the  Bank  is  under  legal  obligation  to  redeem  its  notes 
for  gold  at  the  rate  of  77s  10%d  per  ounce.  This  ap- 
pears at  first  sight  to  limit  the  selling  price,  but  on 
account  of  the  right  of  the  Bank  to  pay  out  light  weight 
coins  for  the  notes  the  maximum  is  raised  to  practically 

VII— 9 


130  MONEY  AND  BANKING 

78s  per  ounce.  There  is  a  tacit  understanding  that  the 
Bank  is  to  have  preference  when  it  is  willing  to  pay  the 
best  price  offered  by  any  other  bidder. 

The  fact  that  the  bank  of  England  must  buy  and  sell 
all  the  gold  offered  at  the  prices  fixed  by  law,  makes  it 
very  difficult  for  England  to  hold  her  supply  of  gold 
when  other  nations  are  bidding  high  for  it  by  maintain- 
ing high  interest  rates.  England  for  this  reason  is 
called  a  "free"  gold  market.  The  Bank  of  England 
exercises  control  over  the  gold  supply  by  manipulating 
the  rate  of  discount,  a  rise  in  the  rate  discourages  both 
foreign  and  domestic  borrowing  not  only  at  the  Bank 
but  from  all  other  banks  who  are  forced  to  follow  the 
lead  of  the  Bank  in  the  rate.  This  means  of  control 
is  effective,  but  it  is  expensive  to  the  business  interests 
of  the  country  to  whom  the  difference  of  1  per  cent 
in  interest  payments  means  a  great  deal. 

161.  Bank  of  France. — During  1907,  the  system  of 
France  seems  to  have  been  superior;  while  there  were 
stringencies  in  all  other  markets,  while  the  rate  of  the 
Bank  of  England  was  held  for  a  long  time  at  6  per  cent, 
customers  of  the  Bank  of  France  could  always  get  funds 
at  3  per  cent.  The  Bank  of  France  has  a  monopoly  of 
note  issue,  but  it  is  not  compelled  to  redeem  its  notes  in 
gold.  When  it  desires  to  protect  its  gold  reserve,  the 
Bank  of  France  refuses  to  pay  out  gold  in  quantities 
for  export  except  at  a  premium.  This  premium  is  never 
so  high  that  would-be  exporters  are  induced  to  gather  up 
the  outside  gold  at  considerable  expense,  but  it  is  high 
enough  to  discourage  lending  in  foreign  markets  by 
French  capitalists  without  interfering  with  foreign 
trade. 

Proximity  of  the  quotations  for  demand  sterling  to 
the  minimum  or  maximum  gold  points  indicates  an  ap- 


DOMESTIC  AND  FOREIGN  EXCHANGE        131 


preaching  export  or  import  of  gold.     High  quotations 
indicate  exports,  while  low  quotations  indicate  imports. 

162.  Gold  shipments. — Shipments  of  gold  interfere 
with  the  basis  of  credit  and  are  therefore  carefully 
watched  by  everybody  whose  interest  can  be  affected 
by  changed  conditions  in  the  credit  market.     The  rate 
of  interest  and  especially  the  rate  of  call  loans  is  some- 
times changed  quite  suddenly  on  this  account.     A  sud- 
den weakening  of  the  call  loan  rates  is  very  likely  to  lead 
to  a  calling  of  loans  based  on  securities  as  collateral 
with  the  result  that  stocks  are  likely  to  be  thrown  on 
the  market  for  sale,  thus  depressing  prices.     This  ex- 
plains the  close  relation  between  the  foreign  exchange 
market  and  the  stock  exchange. 

163.  Our  foreign  commerce. — It  is  a  well-known  fact 
that  according  to  the  official  figures  given  out  at  the 
Custom  House  our  exports  considerably  exceed  our  im- 
ports.    The  figures  for  the  past  ten  years  appear  as 
follows : 

STATISTICS  OF  FOREIGN  TRADE  OF  UNITED  STATES.i 


Twelve  months 
ending  June  30. 


Total 
Imports. 


1898. $   616,049,654 

1899 697,148,489 

1900 849,941,184 

1901 823,172,165 

1902 903,320,948 

1903 1,025,719,237 

1904 991,087,371 

1905 1,117,513,071 

1906 1,226,562,446 

1907 1,434,421,425 

1908 1,194341,792 

These  figures  indicate  that  we  are  selling  a  great  deal 
more  than  we  are  buying  from  foreign  countries  and 
the  natural  inference  would  be  that  we  receive  the  bal- 
ance due  us  from  this  trade  in  gold.  This  is  far  from 

iPage  1843  of  Monthly  Summary  of  Commerce  and  Finance  of  the  U. 
S.,  April,  1909. 


Total 

Excess  of 

Exports. 

Exports. 

$1,231,482^30 

$615,432,676 

1,227,023,302 

529,874,813 

1,394,483,082 

544,541,898 

1,487,764,991 

664,592,826 

1,381,719,401 

478,398,453 

1,420,141,679 

394,422,442 

1,460,827,271 

469,739,900 

1,518,561,666 

401,048,595 

1,743,864,500 

501302,054 

1,880,851,078 

446,429,653 

1,860,773346 

666,431,554 

132  MONEY  AND  BANKING 

being  the  case.  In  the  year  1898  our  excess  of  exports 
was  $666,000,000,  while  our  imports  of  gold  were  $76,- 
000,000.  In  the  year  1905  our  excess  of  imports  was 
$400,000,000  while  we  actually  exported  $390,000,000 
worth  of  gold.  The  figures  for  the  export  and  import 
of  gold  for  ten  years  1898-1908  are  given  below.  This 
ten  year  average  of  imports  is  considerably  higher  than 
previous  decades. 

MOVEMENT  OF  GOLD  TO  AND  FROM  THE  UNITED  STATES.* 

Twelve  months          Total  Total  Excess  of         Excess  of 

ending  Imports.  Exports.  Imports.  Exports. 

June  30. 

1901 $  66,051,187  $53,185.177  $12,866,010  $ 

1902 52,021,254  48,568,950  4,452,304 

1903 44,982,027  47,090,595  «,108,568 

1904 99,055,368  81,459,986  17,595,382 

1905 53,648,961  92,594,024  38,945,063 

1906 96,221,730  38,573,591  57,648,139 

1907 114,510,249  51,399,176  63,111,073 

1908 148,337,321  72,432,924  75,904,397 

164.  Invisible  items  of  foreign  trade. — Even  though 
we  do  not  get  paid  for  our  excess  of  exports  in  gold, 
nevertheless  we  are  paid  for  them  in  some  form  or 
other.  The  figures  of  imports  and  exports  include  only 
the  goods  which  pass  through  the  Custom  House. 
There  are  many  kinds  of  transactions  requiring  pay- 
ments of  money  which  are  never  reported  at  the  Cus- 
tom House  at  all  and  yet  their  effect  upon  the  trade 
balance  is  the  same  as  merchandise.  In  the  last  decade 
the  capital  of  the  world  has  become  more  and  more 
mobile  as  the  facilities  for  loaning  and  investing  in 
foreign  countries  reached  a  higher  perfection  through 
the  banks  and  stock  exchanges.  England  has  always 
owned  a  very  large  amount  of  American  stocks  and 
bonds  representing  investments  in  our  industries.  It  is 

i  Monthly  Journal,  April,  1909,  p.  1849. 


DOMESTIC  AND  FOREIGN  EXCHANGE        133 

said  that  the  larger  part  of  the  capital  used  to  construct 
our  railroads  before  1885  belonged  to  England. 
American  securities  are  so  extensively  dealt  in  on  the 
London  exchange  that  the  closing  quotations  on  the 
London  prices  for  them  at  the  end  of  the  day,  which 
come,  due  to  the  difference  in  time,  at  the  opening  of 
our  own  exchanges  in  this  country,  have  an  important 
effect  upon  quotations  here. 

165.  Movements  of  capital. — In  recent  years  the  well- 
known  thrift  of  the  French  people  has  induced  our 
financiers  to  make  unusual  efforts  to  establish  a  market 
for  certain  American  securities  in  Paris.  The  Pennsyl- 
vania Railroad  Company  sold  a  very  large  issue  of 
bonds  in  that  country  and  at  the  present  writing  Mor- 
gan and  Company  are  eagerly  seeking  the  privilege  of 
listing  the  securities  of  the  United  States  Steel  Corpo- 
ration on  the  Paris  Bourse. 

The  United  States  is  just  coming  to  be  a  market  for 
foreign  securities.  The  only  foreign  security  which  is 
at  present  quoted  on  our  exchange  is  the  Japanese  war 
bonds.  Portions  of  bond  issues  of  South  American 
states,  such  as  Peru  and  Chili,  are  occasionally  allotted 
to  American  bankers  to  be  disposed  of  in  this  country. 

The  movement  of  these  securities  to  and  fro  is  the 
most  potent  cause  of  fluctuation  in  the  foreign  exchange 
market.  Stocks  are  probably  the  first  thing  in  the 
country  to  feel  the  effect  of  the  tendency  to  higher 
prices,  caused  by  an  increased  amount  of  money  or 
credit.  A  very  small  rise  in  the  quotations  of  securities 
is  sufficient  to  cause  considerable  selling  of  them  in  this 
market,  which  has  a  tendency  to  create  a  demand  for 
foreign  exchange  to  pay  for  them,  hence  a  rise  in  the 
price  of  exchange  until  exports  of  gold  are  induced. 

This  explains  why  an  issue  of  paper  money  can  drive 


134  MONEY  AND  BANKING 

an  equal  amount  of  gold  out  of  the  country  so  quickly, 
even  before  the  prices  of  commodities  have  felt  the 
change.  The  more  highly  developed  the  financial  in- 
stitutions of  the  world  the  more  sensitive  will  every 
country  become  to  price-changing  influences. 

166.  Interest  and  dividend  payments  to  foreign  stock- 
holders.— Another   item   of   trade    which    affects    the 
balance  without  appearing  in  the  Custom  House  figures 
is  the  interest  and  dividend  payments  made   to  the 
holders  of  American  securities.     These  payments  are 
made  in  foreign  exchange  and  create  a  demand  for  it, 
hence  they  have  a  tendency  to  lift  the  price  of  foreign 
exchange  away  from  the  gold  import  point. 

167.  Freight. — Most  of  the  merchandise  which  is 
moved  to  or  from  the  United  States  is  carried  in  foreign 
ships.     Since  1846  the  Americans  have  found  them- 
selves at  a  disadvantage  compared  with  England  and 
Germany  in  the  carrying  trade  of  the  world  and  the 
result  is  that  we  must  pay  freight  charges  to  foreign 
companies.     These  payments  are  made  in  foreign  ex- 
change and  help  to  create  a  demand  to  offset  the  exces- 
sive supply  of  bills  on  the  market. 

168.  Tourists. — There  is  still  another  item  which  does 
not   appear  in  the  official  figures.     Since   European 
travel  has  become  so  popular  there  has  arisen  a  large 
demand  for  letters  of  credit  on  the  part  of  tourists. 
The  effect  of  these  letters  of  credit  is  to  create  a  de- 
mand for  bills. 

These  four  items,  namely,  securities  owned  abroad, 
interest  and  dividend  payments  to  the  holders  thereof, 
freight  charges  to  foreign  ship  owners,  and  tourists'  ex- 
penses in  Europe  in  excess  of  European  travel  in 
America — represent  the  equivalent  of  the  excess  of 


DOMESTIC  AND  FOREIGN  EXCHANGE       135 

goods  we  export  over  those  we  receive  from  foreign 
countries. 

169.  Foreign  exchange  market. — Below  are  repro- 
ductions of  a  daily  article  on  the  foreign  exchange  mar- 
ket from  the  Wall  Street  Journal: 

[February  24,  1909.] 

The  foreign  exchange  market  opened  strong,  with  demand 
sterling  4.8760@4.8765,  up  ten  points  from  Saturday's  close. 
There  was  a  good  inquiry  for  remittance,  attributed  to  foreign 
selling  of  stocks  here,  and  on  account  of  the  London  settlement. 

The  market  remained  strong  for  the  first  hour's  trading,  in 
which  demand  sterling  went  to  4.8765@4.8770,  but  it  became 
evident  then  that  there  was  not  sufficient  buying  power  and  the 
market  thereafter  sold  off.  The  opening  strength  was  largely 
influenced  by  the  weak  opening  of  the  stock  market  and  Lon- 
don's sales  of  stocks  here  were  evidently  overestimated.  There 
was  some  buying  of  sterling  cables  for  the  settlement. 

In  the  afternoon  bidding  was  greatly  withdrawn  and  the  mar- 
ket showed  further  ease,  closing  with  demand  sterling  4.8745  @ 
4.8750,  off  fifteen  points  from  the  opening  and  off  five  points 
on  the  day. 

[May  3,  1909.] 

The  foreign  exchange  market  opened  steady,  with  demand 
sterling  4.8740@4.8745,  unchanged  from  Friday's  close. 

The  large  short  interest  which  is  said  to  exist  in  exchange 
was  further  in  evidence  to-day.  The  covering  movement  that 
started  in  on  Thursday  was  continued  with  vigor  during  the 
short  day's  session  demand  sterling  advanced  fifteen  points.  It 
appears  that  a  considerable  part  of  the  present  movement  is  due 
to  the  manipulation  of  one  institution,  which  is  thought  to  be 
"rigging"  the  market. 

The  market  closed  strong  with  demand  sterling  4.8755 @ 
4.8760,  up  fifteen  points  on  the  day. 


136  MONEY  AND  BANKING 

[Compiled  by  Redmond  &  Co.] 

Cables.  Demand.  60-days. 

Sterling  open 4  8760a4  8T65  4  8740a4  8745  4  8620a4  fajj: 

do      closed 4  8770a4  8775  4  8755a4  8760  4  8635a4  8G1^- 

170.  Explanation  of  articles. — Our  purpose  in  re- 
printing these  articles  is  to  acquaint  the  student  with  the 
meaning  of  the  daily  money  articles. 

"The  foreign  exchange  market  opened  up  ten  points 
from  Saturday's  close." 

A  point  in  foreign  exchange  is  1/100  of  one  cent. 
The  "London  settlement"  refers  to  the  English  prac- 
tice of  settling  stock  exchange  transactions  fortnightly. 
That  is  to  say,  if  a  customer  gives  an  order  to  a  banker 
to  buy  or  sell  he  is  not  required  to  deliver  or  receive 
the  securities  until  the  next  settling  date.  Because  a 
great  many  speculators  desire  to  close  up  their  com- 
mitments before  the  settlement  date  there  is  likely  to  be 
considerable  foreign  trading  just  before  settlement  time. 
If  the  foreigners  have  been  buying  our  securities  for 
temporary  speculation  they  are  likely  to  close  up  the 
trade  by  selling.  If  they  have  been  selling  short  they 
are  likely  to  purchase  securities  just  before  the  settle- 
ment. 

"The  opening  strength  was  largely  influenced  by  the 
weak  opening  of  the  call  market  and  London  sales  of 
stock  here  were  evidently  overestimated." 

The  sales  of  American  stocks  by  London  traders 
would  naturally  give  rise  to  a  demand  for  exchange  with 
which  to  settle.  Lower  prices  in  the  New  York  market 
would  induce  foreign  selling  and  thus  strengthen  the 
foreign  exchange  market. 

"There  was  some  buying  of  sterling  cables  for  the 
settlement." 

171.  Cables. — A   cable   means   the   transference   of 
credits  by  means  of  cable  messages.    Dealers  in  se- 


DOMESTIC  AND  FOREIGN  EXCHANGE        137 

curities  who  find  that  they  have  a  balance  against  them 
just  before  settlement  time  in  London  have  not  sufficient 
time  to  buy  other  forms  of  sterling  exchange  and  send 
them  by  mail.  In  order  to  meet  their  obligations  in 
London  they  are  obliged  to  provide  funds  in  the  market 
at  once. 

"A  large  short  interest  which  is  said  to  exist  in  ex- 
change was  further  in  evidence  to-day." 

Foreign  exchange  is  bought  and  sold  speculatively 
in  much  the  same  way  as  stocks.  If  the  dealer  believes 
that  the  price  is  going  down  in  the  near  future  because 
of  the  prospects  of  an  unusual  supply  of  bills  or  because 
of  an  unusually  light  demand  he  may  "sell  short." 
That  is  he  will  contract  to  provide  exchange  at  a  given 
price  at  a  future  time.  A  short  interest  existing  in 
sterling  exchange  will  have  the  same  effect  upon  prices 
of  exchange  as  the  same  condition  existing  in  stocks. 
A  person  who  has  sold  short  must  ultimately  buy  the 
thing  he  has  agreed  to  deliver  and  this  buying  or  "cov- 
ering" by  shorts  is  likely  to  sustain  prices  even  in  the 
face  of  adverse  conditions. 

"The  covering  movement  that  started  in  Thursday 
was  continued  with  vigor." 

For  some  reason  on  this  particular  date  the  shorts 
concluded  that  prices  were  going  higher  and  made  all 
haste  to  purchase  in  order  to  make  deliveries  before  the 
quotations  went  higher  yet. 

"It  appears  that  a  considerable  part  of  the  present 
movement  is  due  to  the  manipulation  of  one  institution 
which  is  thought  to  be  'rigging'  the  market." 

Here  again  we  find  another  similarity  between  the 
market  for  foreign  exchange  and  the  stock  market. 
Exchange  is  manipulated  by  artificially  interfering  with 
the  bidding  and  offering.  The  manipulator  who  de- 


138  MONEY  AND  BANKING 

sires  to  buy  or  sell  either  depresses  or  raises  the  market 
quotations  by  purchases  and  sales,  the  object  being  to 
inspire  similar  buying  or  selling  on  the  part  of  people 
who  see  prices  going  up  or  down  and  wish  to  partici- 
pate in  the  advance  or  decline,  as  the  case  may  be. 

The  manipulator  is  able  to  advance  prices  by  pur- 
chases but  if  he  is  unable  to  sell  out  before  the  price 
has  declined  to  its  previous  level  he  makes  nothing  by 
the  transaction.  The  manipulator  always  expects  that 
his  selling  will  have  a  less  effect  on  prices  than  the  buy- 
ing. Otherwise  he  gains  nothing  in  the  transaction. 

172.  Varieties  of  foreign  exchange. — There  are  four 
different  varieties  of  sterling  exchange  quoted  above. 
Cables  we  have  already  described  as  transfers  of  credit 
which  take  place  within  an  hour  or  two. 

Dealers  who  have  sold  time  drafts  on  London  without 
having  deposited  credits  there  sometimes  postpone  the 
forwarding  of  funds  until  the  drafts  have  reached 
maturity.  They  do  this  hoping  perhaps  that  the  market 
will  decline  before  the  maturity  date  and  thus  enable 
them  to  purchase  exchange  at  a  greater  profit.  Having 
waited  so  long  without  purchasing  demand  sterling  they 
are  obliged  to  go  into  the  market  for  cables  at  the  last 
moment.  It  will  be  noticed  that  the  price  of  cables  is 
twenty  points  above  the  price  of  demand  sterling.  This 
difference  represents  the  price  of  cable  messages  and 
also  the  interest  for  six  or  seven  days.  The  dealer  who 
sells  a  demand  draft  knows  that  the  funds  cannot  be 
called  for  in  London  until  the  draft  has  reached  that 
city  by  mail,  which  at  the  very  best  must  require  at  least 
six  days.  In  the  meantime  his  London  account  is  draw- 
ing interest. 

173.  Demand    sterling. — Demand    sterling    repre- 
sents a  draft  which  is  payable  on  presentation  and  de- 


DOMESTIC  AND  FOREIGN  EXCHANGE        139 

mand.  It  will  be  noted  that  there  is  a  difference  of 
five  points  between  the  quotations  at  opening  and  clos- 
ing. This  difference  is  accounted  for  by  the  difference 
in  quality  of  the  drafts  in  the  matter  of  security. 
Drafts  drawn  by  the  best  known  and  most  reliable  in- 
stitutions command  a  slightly  higher  price  than  those 
issued  by  weaker  firms.  Bank  drafts  command  higher 
price  than  commercial  drafts  accompanied  by  bills  of 
lading  and  other  documents.  The  price  of  the  ninety 
day  drafts  is  nearly  2  cents  per  pound  sterling  less 
than  for  demand  drafts.  This  difference  is  accounted 
for  by  the  fact  that  the  purchaser  of  the  draft  must  wait 
ninety  days  before  he  can  demand  payment.  The  2 
cents  represents  the  interest  for  the  ninety  days. 

A  point  must  be  noted  here  that  is  of  great  import- 
ance in  understanding  the  use  of  finance  bills.  The  rate 
of  interest  which  is  to  be  subtracted  from  the  quotation 
for  demand  sterling  in  order  to  get  the  equivalent  for 
ninety  days  drafts  is  reckoned  at  the  English  current 
rate  of  interest,  even  if  the  quotations  are  given  out  in 
New  York.  The  reason  for  this  is  that  the  purchasers 
of  the  bills  may  send  them  at  once  to  London  and  redis- 
count them  there  at  current  rates  of  interest  and  if  they 
choose  to  realize  on  the  funds  may  sell  demand  sterling 
at  the  market  price,  even  before  they  forward  the  ninety 
day  bills. 

174.  English  banking  customs. — There  exists  in 
England  a  class  of  bankers  called  bill  brokers  whose 
function  it  is  to  discount  time  drafts  for  persons  who 
desire  to  realize  funds  immediately  and  who  are  willing 
to  pay  a  consideration  to  avoid  waiting  until  the  ma- 
turity of  drafts.  So  universal  is  the  custom  in  England 
of  drawing  drafts  for  accounts  payable  that  the  rate 
of  discount  is  more  important  than  the  rate  of  loaning 


140  MONEY  AND  BANKING 

funds.  Most  English  business  men  have  no  direct  re- 
lations with  banks  but  deal  through  these  bill  brokers 
in  much  the  same  way  that  in  legal  matters  English 
people  deal  directly  with  a  solicitor  who  represents  a 
barrister,  who  is  the  one  who  appears  in  court  and 
actually  handles  the  case.  The  rate  at  which  the  long 
bills  can  be  discounted  in  London  depends  very  closely 
upon  the  official  rate  at  the  Bank  of  England. 

Very  few  of  the  bill  brokers  expect  to  hold  the  bills 
until  maturity,  but  they  expect  to  rediscount  them  at 
one  of  the  large  banks ;  their  profit  lies  in  the  difference 
between  the  discount  which  they  get  from  the  customer 
and  that  they  have  to  pay  the  bank.  The  large  stock 
banks  of  London  are  under  normal  circumstances  will- 
ing to  discount  bills  at  about  y2  per  cent  less  than  the 
Bank  of  England.  Therefore  the  official  bank  rate  is 
nearly  always  higher  than  the  actual  rate. 

The  official  rate  of  the  Bank  of  England  has  such  an 
important  effect  upon  credit  conditions  in  this  country 
that  it  is  worth  while  to  understand  the  mechanism  by 
which  the  relation  is  kept  so  close. 

175.  Finance  bills. — Interest  rates  in  the  two  coun- 
tries are  equalized  by  means  of  finance  bills.  A  finance 
bill  is  a  draft  drawn  by  a  banker  in  this  country  upon  a 
foreign  bank  for  the  purpose  of  realizing  funds  here 
for  the  time  being  and  with  the  intention  of  meeting 
the  draft  at  maturity  by  the  purchase  of  demand  ster- 
ling or  cables.  It  is  simply  a  method  by  which  a  banker 
borrows  money  in  a  cheap  market  and  loans  it  in  a  dear 
one.  A  concrete  case  will  make  the  subject  clear. 

Suppose  the  actual  rate  of  discount  in  London  is  5 
per  cent  and  that  the  rate  in  this  country  is  6  per  cent. 
If  a  banker  is  able  to  borrow  funds  in  England  and  re- 
loan  them  in  this  country  he  will  be  able  to  make  a  profit 


DOMESTIC  AND  FOREIGN  EXCHANGE        141 

of  1  per  cent  per  annum,  less  the  expense  of  doing  busi- 
ness. A  banker  desiring  to  engage  in  this  transaction 
is  not  obliged  to  actually  borrow  the  funds  in  England 
and  ship  the  gold  to  this  country.  He  can  accomplish 
the  same  purpose  with  less  expense  and  loss  of  time  by 
drawing  a  ninety  day  draft  against  a  London  bank  and 
selling  it  in  the  foreign  exchange  market  and  loaning 
the  proceeds  at  the  prevailing  rate.  The  price  he  will 
realize  for  the  ninety  day  draft  will  be  the  price  of  de- 
mand drafts  less  a  discount  equivalent  to  the  London 
rate,  as  we  have  explained  above  in  connection  with  the 
quotations  on  ninety  day  drafts. 

It  is  not  necessary  that  the  banker  have  a  deposit 
credit  abroad;  under  the  conditions  mentioned  it  would 
be  very  unprofitable  for  him  to  have  a  deposit  when  he 
might  loan  funds  to  such  advantage  in  his  own  country. 
This  lack  of  deposit  credit  does  not  deter  him  from 
drawing  drafts  upon  the  London  bank  if  he  can  make 
some  arrangements  with  the  bank  for  accepting  the 
draft  so  presented  in  order  to  give  it  negotiability  with 
the  bill  brokers.  At  the  expiration  of  the  ninety  days, 
however,  he  is  obliged  to  have  the  funds  in  the  London 
bank  to  meet  the  draft.  These  funds  he  provides  by 
purchasing  demand  sterling  a  week  or  so  before  matur- 
ity in  order  to  give  the  draft  plenty  of  time  to  reach 
England  before  the  draft  is  presented;  or,  if  he  has 
waited  too  long,  he  must  buy  a  cable. 

176.  Profit  on  finance  bills. — The  amount  of  his  profit 
depends  entirely  upon  the  difference  between  the  pro- 
ceeds realized  from  the  sale  of  the  ninety  day  draft 
(which  are  near  the  face  of  the  draft,  as  the  discount 
rate  in  England  is  low) ,  plus  the  interest  he  has  gained 
by  loaning  the  proceeds,  and  the  price  which  he  must 
pay  for  the  means  of  covering  the  draft  at  maturity, 


MONEY  AND  BANKING 

plus  the  commission  for  acceptance  payable  to  the 
English  Bank,  and  the  British  Government  tax  on  bills. 

The  banker  who  issues  finance  bills  is  forced  to  be- 
come a  speculator  in  sterling  exchange  because  his  profit 
depends  upon  the  price  at  which  he  can  buy  demand  ster- 
ling or  cables  eighty  to  ninety  days  after  the  date  of 
issue  of  the  finance  bills.  If  he  wishes  to  make  sure  of 
a  profit  and  shift  the  risk  to  others  who  are  more  specu- 
latively  inclined  or  who  are  better  able  to  forecast  the 
conditions  of  the  supply  and  demand  in  the  foreign  ex- 
change market  in  the  future  he  may  make  a  contract  at 
the  time  of  issuing  the  finance  bills  for  demand  sterling 
eighty  days  after  at  a  certain  fixed  price.  The  issuing 
of  finance  bills  has  the  same  effect  upon  the  market 
value  of  foreign  exchange  as  bills  rising  out  of  commer- 
cial transactions.  If  they  are  issued  in  large  amounts  at 
any  one  time  they  depress  the  market,  but  when  the  time 
of  maturity  of  these  bills  approaches,  the  purchases  of 
demand  sterling  to  cover  stimulate  the  market  artifi- 
cially. 

If  the  condition  of  the  market  is  such  that  gold  im- 
ports are  imminent  the  issue  and  sale  of  finance  bills  is 
likely  to  reduce  the  price  of  bills  just  enough  to  bring 
about  the  import  of  gold.  In  this  case  the  final  result 
is  exactly  the  same  as  borrowing  money  abroad  and 
shipping  it  to  this  country  for  loaning  purposes. 

In  spite  of  this  very  effective  method  of  equalizing 
interest  rates  between  different  countries  there  are  times 
when  the  discrepancy  between  the  rates  is  very  great. 
This  is  accounted  for  by  the  fact  that  unusual  condi- 
tions exist  in  one  country  or  the  other.  The  defects  in 
our  currency  system,  of  which  much  is  to  be  said  later, 
are  responsible  for  great  variations  in  the  interest  rate  in 
New  York.  It  has  been  said  by  financiers  of  authority 


DOMESTIC  AND  FOREIGN  EXCHANGE       143 

that  New  York  can  never  hope  to  become  the  financial 
center  of  the  world  or  compete  with  London  in  that 
respect  as  long  as  it  is  possible  for  the  rate  on  call  loans 
to  exceed  100  per  cent,  or  so  long  as  it  is  possible  for  a 
condition  to  arise  where  a  premium  is  paid  for  cur- 
rency. The  profits  from  the  issue  of  finance  bills  and 
from  other  international  financial  transactions  are  so 
small  when  reckoned  in  per  cent  that  the  variations  of 
our  money  market  destroy  the  delicate  adjustment  by 
making  such  operations  too  speculative  and  risky. 

The  great  advantage  which  London  possesses  over 
every  other  financial  center  is  stability.  Bankers  can 
always  depend  upon  being  able  to  realize  funds  upon 
satisfactory  collateral  in  London  and  take  no  risk  of 
having  their  transactions  absolutely  blocked  by  a  sud- 
den money  panic. 

177.  Foreign  department  of  a  bank. — In  recent  years 
there  has  been  a  great  increase  in  the  foreign  business 
of  banks  and  many  foreign  departments  have  been  es- 
tablished. This  has  been  due  to  the  rapid  extension  of 
our  foreign  commerce  and  the  large  number  of  Amer- 
icans traveling  abroad,  giving  rise  to  a  demand  for 
banking  facilities  to  expedite  the  forwarding  of  funds 
and  the  collection  of  drafts.  Competition  between  the 
banks  has  raised  the  price  paid  for  commercial  drafts 
drawn  by  exporters,  at  the  same  time  it  has  lowered  the 
price  of  drafts  and  banker's  checks  sold  to  importers. 

The  advantages  to  a  bank  arising  from  the  mainte- 
nance of  foreign  department  are,  according  to  Mar- 
graff:1 

1.  The  foreign  department  affords  facilities  to  the 
general  clientele  of  the  bank  to  transact  all  its  banking 
business  with  the  bank,  thereby  avoiding  the  possibility 

1  International  Exchange:  p.  14, 


144  MONEY  AND  BANKING 

of  losing  a  profitable  account  that  is  open  to  successful 
solicitation  by  a  competitor. 

2.  Serves  as  a  valuable  auxiliary  through  the  medium 
of  advertisements  and  personal  invitation  to  attract  de- 
positors. 

3.  Commands  prominence  of  the  name  of  the  bank 
among  New  York  bankers,  by  whom  its  foreign  ex- 
change is  purchased,  and  among  bankers  throughout  the 
entire  world,  with  whom  accounts  are  kept,  and  by 
whom  drafts  against  its  letters  of  credit  are  negotiated. 

4.  Practically  converts  the  bank  into  an  international 
banking  institution,  thereby  vastly  increasing  its  field 
of  operation,  by  placing  it  in  close  touch  with  the  long- 
established  monetary  centers  of  the  world. 

5.  Affords  the  bank  an  opportunity  of  placing  loans, 
at  remunerative  rates  of  interest,  in  European  money 
markets  when  favorable  conditions  prevail,  by  the  pur- 
chase of  bills  of  exchange  as  an  investment. 

6.  Affords  the  bank  an  opportunity  of  borrowing 
funds  by  means  of  finance  bills  in  any  monetary  center 
of  the  world. 

The  foreign  department  of  a  bank  usually  transacts 
the  following  business : 

1.  Sells  letters  of  credit  to  travelers  and  commer- 
cial houses. 

2.  Sells  drafts  to  persons  desiring  to  send  money 
abroad. 

3.  Buys  drafts  drawn  by  exporters  on  foreign  con- 
signees. 

In  addition  to  these  transactions,  the  possession  of  a 
foreign  department  gives  the  large  international  banker 
a  chance  to  borrow  money  abroad  to  loan  at  a  higher  rate 
of  interest  at  home  by  means  of  finance  bills,  or  to 
invest  funds  in  sterling  bills  of  exchange  and  thus 


DOMESTIC  AND  FOREIGN  EXCHANGE        145 

realize  a  higher  rate  of  interest  than  he  could  get  by 
loaning  at  home,  or  to  engage  in  profitable  arbitrage 
transactions. 

178.  Traveler's  letters  of  credit. — So  many  Ameri- 
cans travel  abroad  in  these  days  that  there  is  a  large 
demand  for  letters  of  credit.  It  is  so  much  more  con- 
venient for  people  to  obtain  these  letters  from  banks 
with  whom  they  have  an  account  that  if  they  are  com- 
pelled to  get  them  from  other  banks  they  are  likely  to 
transfer  their  accounts  to  those  banks. 

Letters  of  credit  may  be  issued  in  three  ways: 

1.  The  purchaser  buys  the  letter  outright  and  pays 
cash  for  it  at  once.     The  banker  sells  it  to  him  at  the 
selling  price  of  demand  exchange  for  that  day  plus  1 
per  cent  commission.     Thus  a  letter  for  £1,000  with 
demand  sterling  selling  at  $4,8550,  would  cost  $4855 
plus  $48.55  or  $4903.55. 

2.  If  the   applicant  is   a   depositor   enjoying  high 
credit,  the  bank  is  willing  to  issue  to  him  a  letter  with- 
out payment  until  the  customer  has  drawn  money  upon 
the  letter  and  the  drafts  have  been  received  by  the  sell- 
ing bank. 

3.  If  the  applicant  is  not  a  depositor  or  one  having 
sufficient  credit,  the  bank  will  issue  a  letter  upon  the 
deposit  of  collateral  security  to  secure  the  amount. 

Under  the  last  two  methods,  the  customers  are  not 
debited  with  the  amounts  until  the  drafts  which  they 
have  signed  to  draw  out  the  money  abroad  have  been 
returned  to  the  bank.  These  drafts  are  charged  at  the 
current  selling  rate  of  sterling  exchange  plus  1  per 
cent  commission  plus  interest  on  the  amount  for  thirty 
days  while  the  draft  is  coming  from  England  and  while 
the  remittance  to  cover  same  is  going. 

A  bank  can  place  itself  in  position  to  sell  letters  of 

VII— 10 


146  MONEY  AND  BANKING 

credit  by  making  arrangements  with  a  London  banker 
who  has  a  large  number  of  correspondents  over  the 
world  to  cash  drafts  drawn  by  the  holders  of  letters. 
A  specimen  copy  of  the  letter  with  the  signatures  of  the 
manager  of  the  department  is  sent  to  every  correspond- 
ent of  the  London  banker. 

When  a  person  presents  a  letter  of  credit  obtained 
from  a  Philadelphia  bank  addressed  to  the  London  City 
and  Midland  Bank  and  its  correspondents  to  the 
Deutsche  Bank  in  Berlin,  for  instance,  they  will  com- 
pare the  letter  with  the  specimen  on  file,  then  they  will 
write  out  a  draft  on  the  London  City  and  Midland 
Bank  which  they  will  ask  the  person  presenting  to  sign. 
If  the  person  has  asked  for  <£10,  they  will  give  him  for 
the  draft  the  amount  in  marks  which  they  are  paying 
for  sterling  drafts  on  that  day.  If  the  price  of  sterl- 
ing drafts  is  M  20.43  per  <£,  the  person  is  entitled  to 
M  204.30  for  the  £10  draft  which  he  signed  and  which 
was  endorsed  on  the  letter  of  credit. 

The  reason  why  banks  are  always  so  willing  to  cash 
letters  of  credit  is  because  of  the  great  demand  for 
sterling  exchange  everywhere.  When  the  bank  has 
bought  a  draft  for  .£10,  it  sends  it  to  London  for  credit 
and  can  immediately  sell  a  draft  for  £10  against  this 
credit. 

The  London  City  and  Midland,  when  it  receives  the 
draft  from  the  Deutsche  Bank,  credits  it  to  their  ac- 
count and  charges  it  against  the  Philadelphia  bank. 
The  Philadelphia  bank  must  provide  funds  in  London 
by  buying  sterling  exchange  at  home. 

179.  Commercial  letters  of  credit. — These  are  used 
by  importers  to  purchase  goods  abroad.  By  means  of 
them  merchandise  can  be  purchased  in  any  part  of  the 
globe  on  a  cash  basis,  although  actual  payment  of  the 


DOMESTIC  AND  FOREIGN  EXCHANGE         147 

cost  of  the  goods  imported  will  not  be  demanded  of  the 
importers,  by  the  banker  furnishing  the  credit,  until 
maturity  of  respective  drafts  drawn  by  the  exporters. 
Advance  orders  may  be  given  by  importers  with  expor- 
ters for  the  manufacture  of  goods,  according  to  the 
specifications  and  requirements  of  the  importers,  without 
prepayment  of  the  value  of  the  goods  ordered,  or  a  cash 
deposit,  the  commercial  letter  of  credit  being  sufficient 
security  in  the  hands  of  the  exporters. 

The  exporters  are  benefited  because  they  receive  cash 
for  all  merchandise  ordered  under  the  letter  of  credit 
on  the  date  of  the  shipment ;  that  is  to  say,  drafts  cover- 
ing the  cost  of  merchandise,  even  if  issued  for  a  spec- 
ified time  after  sight  can  be  converted  into  cash  by  dis- 
counting such  drafts  with  their  local  bankers.  The 
buyer  of  the  letter  of  credit  signs  an  agreement  to  reim- 
burse the  bank  for  the  drafts  drawn  under  the  letter  at 
the  current  rate  of  exchange  and  to  pay  a  commission 
of  1  per  cent  on  drafts  at  sixty  days  5  sight.  The  fact 
that  the  drafts  are  drawn  at  sixty  days  obviates  the 
necessity  of  charging  interest,  for  the  London  bank  does 
not  pay  the  drafts  until  sixty  days  after  the  goods  have 
been  shipped  and  the  bank  notified  that  the  draft  has 
been  made. 

When  the  foreigner  has  the  goods  ready  for  shipment 
he  draws  the  draft  and  discounts  it  with  the  local 
banker,  the  letter  of  credit  making  it  secure  and  worth 
more  than  an  ordinary  commercial  draft.  The  dis- 
counting bank  either  holds  it  until  maturity  or  sends  it 
to  London  for  discount.  Before  it  is  due  the  American 
bank  provides  funds  in  London  to  cover  it. 

180.  Buying  foreign  exchange  for  investment. — 
Suppose  the  rate  of  interest  at  home  is  very  low  at 
the  same  time  it  is  high  abroad.  The  international 


148  MONEY  AND  BANKING 

banker  finds  that  he  could  make  profit  by  loaning  in  the 
better  market.  He  can  do  this  very  easily  by  purchas- 
ing "long"  bills  and  holding  them  himself  instead  of 
sending  them  abroad  for  discount.  This  he  could  easily 
do  by  detaching  the  first  of  exchange  (foreign  bills 
are  always  made  out  in  triplicate)  and  instead  of  indors- 
ing it  for  discount,  would  write  across  the  face:  "For 
acceptance  only."  The  correspondent  bank  receiving 
same  would  secure  acceptance  and  hold  it. 

At  the  end  of  the  period  for  which  the  bill  ran,  or 
at  any  time  before,  if  the  holder  found  that  he  needed 
the  funds,  the  holder  could  take  the  second  of  ex- 
change, endorse  it  for  collection  and  send  it.  The  first 
containing  the  acceptance  and  the  second  containing  the 
endorsement  would  together  constitute  a  complete  bill. 
The  correspondent  would  collect  (or  discount  them  if 
they  were  not  yet  due)  and  place  the  proceeds  to  the 
credit  of  the  sending  bank. 

Suppose  demand  sterling  were  selling  at  $4.85,  the 
Bank  of  England  rate  was  6  per  cent  and  the  average 
bank  rate  in  this  country  was  4  per  cent.  In  this  case 
the  price  of  bills  would  be:  * 

Open  discount  rate  in  England  5y2%. 
90  days'  interest  at  5y2  on  $4.85  =  .0666 
British  Bill  Stamps     '  =.0020 

Commission  1-40%  =.0012 


.0698 


Therefore  the  price  of  ninety-day  bills  would  be 
$4.85— .07=$4.78. 

Suppose  the  banker  purchased  £10,000  of  ninety-day 
bills  at  $4.78;  the  cost  would  be  $47,800.  At  the  end 
of  the  ninety  days  he  would  be  able  to  sell  £10,000  of 
demand  sterling,  say  at  $4.85  (if  the  price  had  not  fluc- 

1  Margraff,  "  International  Exchange,"  p.  133, 


DOMESTIC  AND  FOREIGN  EXCHANGE        149 

tuated),  or  a  total  of  $48,500.  His  profit  would  be 
48,500— $47,800  or  $700.  If  he  had  loaned  the  $47,- 
800  at  3  per  cent,  he  could  have  gained  in  interest  only 
$358.50.  The  net  profit  on  the  exchange  would  there- 
fore be  $341.50. 

181.  German  and  French  exchange. — The  mone- 
tary unit  of  Germany  is  the  mark  which  contains  one 
hundred  pfennings.  Measured  in  gold,  it  is  equiva- 
lent to  $.238309  in  United  States  money.  The  quota- 
tions for  exchange  in  marks,  however,  are  quoted,  not 
as  the  price  of  one  mark,  but  as  the  price  of  four  marks. 
For  example,  demand  sterling  was  recently  quoted  at 
$.94  7-16  less  1-32,  meaning  that  drafts  on  German 
banks  were  sold  at  $.94  7-16  less  1-32  for  every  four 
marks.  "Less  1-32"  means  that  1-32  per  cent  of 
$.94  7-16  must  be  deducted  from  $.94  7-16  to  get  the 
true  quotation.  Expressed  decimally  the  quotation 
would  be  .94  .0043  less  .0003  or  $.9440. 

In  foreign  exchanges  the  expression  "per  mille"  is 
often  used.  One-half  per  mile  (written  1-2  0-00)  % 
per  thousand  or  1-20  per  cent.  It  is  a  more  convenient 
term  that  fractional  percentages. 

The  French  monetary  unit  is  the  franc,  divided  into 
one  hundred  centimes.  Measured  in  gold,  it  is  equiv- 
alent to  $.19295  in  our  money.  The  quotations  for 
French  exchange  are  given  exactly  opposite  the  Eng- 
lish or  German — that  is,  they  quote  the  number  of 
francs  which  one  dollar  will  purchase.  A  recent  quota- 
tion for  demand  exchange  on  Paris  was  5.16  7-8  less 
1-32.  This  means  that  5.16  7-8  less  1-32  per  cent  francs 
will  be  sold  for  $1.  It  will  be  noted  that  the  larger 
the  figures,  the  lower  the  quotations  and  vice  versa: 
5.15  is  a  higher  quotation  than  5.16. 

The  quotations  vary  1-8  per  cent  or  in  intervals  of  5-8 


150  MONEY  AND  BANKING 

centime  (because  5-8  centime  is  approximately  1-8  per 
cent  of  5.15  francs,  the  basis  of  computation) .  The  in- 
tervals begin  with  5.15  and  go  down  thus:  5.15  5-8, 
5.16  1-4,  5.16  7-8,  5.17  1-2,  5.18  1-8,  5.18  3-4,  etc.  The 
reason  for  this  is  the  fact  that  formerly  1-8  per  cent  was 
close  enough  for  the  brokers  and  was  a  convenient  figure 
in  arbitrage  transactions.  Recently  prices  are  quoted 
closer  and  the  quotations  are  raised  and  lowered  by  de- 
ducting or  adding  1-16  per  cent,  1-32  per  cent  or  1-64 
per  cent. 

In  order  to  deal  with  such  awkward  quotations  it  is 
necessary  to  convert  them  into  decimals,  for  it  is  im- 
possible to  find,  for  instance,  5  per  cent  on  5.16  7-8  less 
1-32.  To  convert  5.16  7-8  less  1-32  into  a  decimal,  we 
would  first  find  the  decimal  equivalent  of  .007-8  = 
.00875;  then  we  would  find  1-32  per  cent  of  5.16  7-8 
=  .00156  +  5.16  +  .00875  =  5.16875.  To  this  we 
must  add  .00156  =  5.17031.  It  is  added  because  "less 
1-32  per  cent"  means  a  lower  quotation;  since  the  higher 
the  figures  are  the  lower  the  actual  quotation  must  be, 
the  reason  for  adding  the  decimal  instead  of  subtract- 
ing it  is  clear. 

To  convert  a  quotation  expressed  decimally  to  the  reg- 
ular fractional  form  is  more  difficult.  Let  us  take,  for 
example,  5.1925. 

The  next  nearest  quotation  fractionally  is  5.19  3-8 
(see  list  above)  or  5.19375,  which  is  too  large  by  .00125. 
.00125  is  equivalent  approximately  to  1-32  per  cent  of 
5.19,  so  we  would  complete  the  quotation  by  reducing 
the  5.19375  by  1-32  per  cent,  making  it  5.19  3-8  plus 
1-32,  plus  representing  a  lowering  of  the  actual  quota- 
tion. 

To  find  the  value  of  a  90  day  bill  on  Paris  for  525 
francs  if  demand  exchange  were  at  5.16  7-8  less 


DOMESTIC  AND  FOREIGN  EXCHANGE        151 

1-32  (5.17031  as  above)  we  would  calculate  the  discount 
and  expenses :  * 

Francs. 

Commission  1-40%  or  yt%  (%  =  PER  MILLE) 13 

French  Bill  Stamp  1-20%  or  1  20-00 36 

Discount  90  days  at  2%% 3.60 


Francs      3.990 
Price  of  demand  exchange 517.031 


Price  of  90-day  exchange 521.021 

Quotation  per  $1.00  worth  of  exchange 5.21 

3.99  francs  are  added  to  the  price  of  demand  because 
90  day  exchange  is  worth  less  than  demand  and  the 
lower  the  quotation,  the  greater  the  number  of  francs 
given  for  $1. 

182.  Arbitrage. — The  arbitrage  transaction  consists 
in  buying  or  selling  exchange  on  a  certain  center  indi- 
rectly through  a  third  city.  For  example,  a  banker 
wishing  to  increase  his  London  balance  would  buy  Ber- 
lin exchange  and  instruct  his  German  correspondent  to 
use  the  proceeds  of  the  bill  in  purchasing  sterling  in 
Berlin,  thus  increasing  his  London  balance  by  the  tri- 
angular operation. 

Suppose  a  banker  had  an  opportunity  to  sell  a  draft 
on  Paris  but  had  no  funds  there.  It  would  be  very 
easy  for  him  to  sell  the  draft,  purchase  with  the  pro- 
ceeds sterling  exchange,  remit  it  to  London  with  in- 
structions to  purchase  Paris  exchange  in  London  with 
the  proceeds  and  forward  for  credit  to  the  Paris  corre- 
spondent to  cover  the  draft  sold  at  first. 

Suppose  the  quotations  for  the  day  were  as  follows: 

Sterling  exchange  in  New  York $  4.84 

Paris  exchange  in  New  York ^.l?1/^ 

Francs  in  London 25.25  per  £ 

i  Margraff,  "  International  Exchange,"  p.  142. 


152  MONEY  AND  BANKING 

If  he  sold  a  draft  for  25,250  francs,  he  would  receive 
therefrom  $4,879.23  (25,250  divided  by  5.175).  To 
cover  this  draft  in  Paris  by  French  exchange  purchased 
in  London,  it  would  be  necessary  for  him  to  buy  sterling 
exchange  at  $4.84.  If  25.25  francs  in  London  sold 
for  <£  he  would  be  required  to  buy  .£1,000  in  order 
to  get  25,250  francs.  This  would  cost  him  in  New 
York  at  $4.84,  $4,840.  His  profit  would  be: 

Proceeds   $4,879.23 

Cost 4,840 


$     39.93 

His  London  banker  would  probably  charge  him  1-40 
per  cent  for  doing  the  business,  which  would  cut  down 
his  profit  by  $1.21,  leaving  it  net  at  about  $38.00. 

The  quotations  in  New  York  for  continental  ex- 
change are  influenced  largely  by  the  price  of  sterling 
exchange,  both  in  New  York  and  in  Berlin  or  Paris. 
If  from  any  cause  the  price  of  continental  exchange  in 
New  York  should  tend  to  fall  to  a  point  where  there 
would  be  a  profit  in  the  arbitrage  transaction,  the  de- 
mand for  it  on  the  part  of  the  bankers  who  wish  to 
make  a  profit  from  arbitraging  would  immediately 
force  up  the  price  again.  Therefore,  there  is  a  certain 
relation  existing  between  all  the  quotations  of  foreign 
exchange.  When  there  is  neither  profit  nor  loss  from 
arbitraging,  they  are  said  to  be  at  par. 

For  instance,  if  demand  sterling  in  New  York  were 
at  $4.8665,  the  unit  par.,  and  in  Berlin  at  20.43,  also  the 
unit  par,  the  commercial  par  of  marks  in  New  York 
could  be  found  by  dividing  4,8664  by  20.43,  equals 
.2383,  the  value  of  one  mark  exchange  in  New  York; 
multiply  it  by  four  (.2383x4=.9582)  and  we  have  the 
commercial  par  of  exchange  for  mark  exchange  which 
is  also  the  mint  par. 


%  CHAPTER  X 

PRODUCTION  OF  THE  PRECIOUS  METALS 

183.  World's  stock  of  gold. — The  total  amount  of 
gold  estimated  to  have  been  produced  in  the  world 
within  historic  times  is  $10,948,899,000.     The  amount 
of  gold  at  present  in  use  throughout  the  world  as  money 
is  $5,685,700,000;  thus  leaving  over  $5,000,000,000  to 
be  accounted  for.     Of  this  amount  it  is  calculated  that 
two  and  a  half  billions  have  been  consumed  in  the  arts, 
and  fifty  millions  have  been  lost  through  the  abrasion 
of  coins;  and  that  $1,300,000,000  has  been  exported 
to  the  Asiatic  countries  where  it  has   been  hoarded 
and  passed  out  of  monetary  use.     This  leaves  unac- 
counted for  about  $1,800,000,000,  which  probably  rep- 
resents the  gold  that  has  been  lost  in  transporting  it 
across  the  sea,  or  has  been  hidden  away  in  the  earth,  or 
is  at  present  in  hoards  of  which  no  record  is  kept. 

184.  History  of  the  precious  metals. — According  to 
the  figures  of  the  production  of  silver  throughout  his- 
toric times  it  is  estimated  that  there  has  been  produced 
over  $12,000,000,000,  which  is  accounted  for  as  follows: 
Consumed  in  the  arts,  $1,750,000,000;  devoted  to  mone- 
tary uses,  $3,213,000,000 ;  exported  to  India  and  China, 
$1,990,000,000.     This  leaves  unaccounted  for  the  sum 
of  five  billions. 

In  ancient  times  there  was  considerable  production  of 
the  precious  metals,  mostly  from  the  mines  of  southern 
Europe.  These  sources  were  worked  by  slave  labor  al- 
most exclusively,  and  the  productions  found  their  way 

153 


154  MONEY  AND  BANKING 

into  great  hoards  which  served  no  valuable  purpose  other 
than  to  provide  a  visible  evidence  of  the  wealth  and 
power  of  the  owner.  Only  a  small  part  of  the  existing 
stock  of  precious  metals  was  used  as  a  circulating  me- 
dium, and  of  course  at  that  time  its  use  as  a  basis  of 
credit  was  entirely  unknown. 

Gold  and  silver  were  regarded  as  an  end,  not  as  a  means;  as 
treasure,  not  money.  They  were  distributed,  not  by  trade,  but 
by  war.  It  was  the  hand  of  the  conqueror  that  stripped  them 
from  palaces  and  temples.  If  they  were  taken  from  the  store 
of  monarchs,  it  was  not  to  freight  the  caravans  of  commerce, 
but  to  fill  the  chariots  and  mule  carts,  to  load  the  sumpter  horses 
or  the  camel  trains  of  a  victorious  army.1 

After  the  fall  of  the  Roman  Empire  the  mines  fell 
into  the  hands  of  the  barbarians  in  their  southern  migra- 
tions and  ceased  to  be  worked.  From  that  time  on 
until  the  discovery  of  America  the  quantity  of  precious 
metals  in  Europe  decreased  rather  than  increased. 
Large  quantities  were  used  in  decorating  the  churches. 
There  was  probably  even  less  used  for  monetary  pur- 
poses than  the  limited  amount  which  had  been  so  used 
in  the  ancient  times. 

185.  The  Feudal  Period. — Under  the  feudal  system 
society  was  organized  on  a  basis  on  which  was  required 
very  little  exchange  of  products,  and  most  of  what 
exchange  existed  was  done  on  a  barter  basis.  Taxes 
and  payments  to  the  lord  of  the  manor  were  made  in 
produce.  The  royal  court  was  maintained  not  from 
money  taxes  collected,  but  from  the  produce  of  the 
crown  lands  which  the  king  received  as  the  lord  of  the 
manor.  Wars  were  conducted  without  the  use  of 
money;  the  soldiers  were  equipped  from  their  own  re- 

i  F.  A.  Walker,  "  Money,"  p.  108. 


PRODUCTION  OF  PRECIOUS  METALS         155 

sources  and  were  sustained  from  the  forage  of  the 
country  traversed  in  campaigns. 

186.  Discovery  of  America. — One  of  the  most  impor- 
tant effects  of  the  discovery  of  America  on  European 
economic  conditions  arose  from  the  quantities  of  silver 
which  began  to  flow  in  an  increasing  stream  from  the 
Spanish  colonies  to  Spain  and  from  thence  to  be  dis- 
bursed throughout  Europe.  The  eager  quest  of  the 
early  explorers  for  the  precious  metals  can  be  better 
understood  when  we  know  that  the  value  of  silver  was 
many  times  its  value  to-day,  and  that  the  precious  metals 
were  about  the  only  property  which  could  be  profitably 
transported  during  these  times  when  transportation 
was  so  difficult  and  expensive. 

When  Columbus  and  the  explorers  who  followed  him  set  out 
on  their  quest  for  undiscovered  countries,  it  was  largely  with  the 
hope  of  finding  gold  and  silver.  Gold  was  found  at  the  outset 
in  Hispaniola,  the  first  island  acquired  by  Columbus  for  Spain, 
but  even  with  the  forced  labor  of  the  natives  it  was  obtained  in. 
only  limited  quantities.  The  quest  for  gold,  at  first  disap- 
pointed, was  more  amply  rewarded  after  the  conquest  of  Mexico 
by  Cortez,  about  1520,  and  of  Peru  by  Pizzaro,  about  1532. 
The  treasures  which  had  been  accumulated  by  many  years  of 
mining  by  the  simple  but  partly  civilized  peoples  of  these  coun- 
tries were  poured  into  Europe  and  were  the  subject  of  most  fab- 
ulous estimates  as  to  their  amounts.  Thus,  the  ransom  of  the 
Inca  of  Peru  extorted  by  Pizzaro — a  sum  equal  to  about  $4,- 
000,000  gold  of  our  money,  and  an  additional  sum  in  silver — 
was  a  large  amount  to  be  distributed  among  a  small  body  of 
adventurers,  but  did  not  add  greatly  to  the  monetary  resources 
of  the  world.  It  was  the  discovery  of  rich  silver  deposits  of  the 
mountain  of  Potosi,  in  Peru,  about  1545,  which  revealed  the 
New  World  as  an  important  producer  of  the  precious  metals 
and  especially  of  silver.  Up  to  this  date  (1493—1545)  the  pro- 
duction of  gold  preponderated  in  the  proportion  of  about  $220,- 


156  MONEY  AND  BANKING 

000,000  to  $144,0001,000  in  silver;  but  from  that  discovery,  fol- 
lowed by  many  others,  began  what  Leroy-Beaulieu  designates  as 
"the  first  age  of  silver."  It  was  an  age  which  lasted  for  nearly 
three  centuries,  terminating  about  1840,  and  which  brought  into 
the  commercial  world  nearly  $6,000,000,000'  of  silver  against 
less  than  half  as  much  gold.1 

187.  Effect  of  silver  from  America. — The  effect  of 
the  American  silver  upon  the  economic  conditions  of 
Europe  was  revolutionary.  Payments  from  the  tenants 
to  the  landlords  for  the  use  of  the  soil  had  been  made 
either  in  produce  or  in  labor,  a  system  which  reduced 
the  tenant  to  a  condition  not  far  removed  from  that  of 
the  slave.  Commerce  was  so  limited  that  every  com- 
munity had  to  be  practically  self-supporting,  and  its 
consumption  was  limited  to  the  articles  which  could  be 
produced  in  the  immediate  vicinity.  The  lack  of  com- 
merce made  it  possible  for  famine  to  exist  in  one  county 
while  great  plenty  existed  in  the  neighboring  county. 

The  transmission  from  payment  in  kind  to  money 
payment,  which  soon  profoundly  altered  the  relations 
between  the  lords  and  tenants,  making  the  latter  much 
more  independent,  was  not  so  much  due  to  the  greater 
abundance  of  money  as  it  was  to  the  effect  produced  by 
the  new  silver  on  prices  of  all  commodities.  The  Span- 
iards to  whom  this  new  silver  first  came,  appeared  in 
the  markets  of  Europe  as  purchasers  of  goods,  thus 
creating  a  steady  demand  for  export.  The  rise  of 
prices  and  the  steady  market  gave  a  stimulus  to  indus- 
try. Originally  money  had  been  used  chiefly  as  a  store 
of  value  and  had  been  hoarded  up  as  a  protection 
against  misfortune.  This  was  justified  from  the  con- 
ditions of  the  time  which  made  it  difficult  to  accumulate 
any  other  form  of  property.  The  land  was  not  bought 

i  C.  A.  Conant,  "  The  Principles  of  Money  and  Banking,"  p.  86. 


PRODUCTION  OF  PRECIOUS  METALS         157 

and  sold  as  to-day,  but  was  considered  permanent  in 
the  possession  of  families  who  held  it  under  various 
forms  of  limited  title  from  the  king  or  lord. 

There  was  very  little  opportunity  to  acquire  produc- 
tive capital.  What  little  invested  capital  there  was 
in  the  form  of  flour  mills,  etc.,  was  held  by  the  lords 
under  the  same  conditions  as  the  land  practically. 
Money  was  therefore  about  the  only  form  of  property 
in  which  savings  could  be  invested.  There  was  no 
incentive  to  circulate  money  except  when  misfortune 
forced  the  possessor  to  release  it  for  the  necessities  of 
life,  or  when  it  was  extorted  by  force. 

188.  Increased  circulation  of  money. — The  rise  of 
prices  accompanied  as  it  was  by  the  growth  of  commerce 
and  by  the  commutation  of  money  for  labor  dues  had 
the  effect  of  putting  money  into  circulation.     As  the 
opportunities  increased  for  the  investment  of  funds  in 
some  form  of  productive  property,  the  tendency  to  hold 
money  grew  less  and  less  especially  as  the  increase  in 
the  value  of  goods  and  the  decline  in  the  value  of  money 
made  the  latter  very  unprofitable  and  a  losing  invest- 
ment. 

It  is  doubtful  whether  the  new  silver  which  flowed 
into  Europe,  when  measured  in  terms  of  value,  increased 
the  amount  of  money.  An  ounce  of  silver  was  worth 
so  much  less  that  the  increased  quantity  had  little  more 
power  to  perform  money  work  than  the  smaller  quan- 
tity had  before.  The  effect  was  produced  by  the 
change  of  prices  and  by  the  consequent  increase  in  the 
circulating  power  of  the  stock  of  silver  already  existing 
in  Europe. 

189.  Discovery  of  gold  in  California. — The  quantity 
of  gold  and  silver  in  the  world  was  subjected  to  an- 
other great  change  in  the  middle  of  the  nineteenth  cen- 


158  MONEY  AND  BANKING 

tury.  On  January  28,  1848,  a  workman  named  Mar- 
shall, while  erecting  a  sawmill  on  the  American  fork 
of  the  Sacramento  River,  discovered  gold  in  the  mill 
race  and  within  three  years  from  that  time  California 
had  not  only  become  a  part  of  the  United  States,  when 
it  had  previously  belonged  to  Mexico,  but  had  also 
been  admitted  as  a  State  under  the  Compromise  of  1850. 
Gold  had  been  discovered  in  Australia  in  1823,  but  min- 
ing had  been  discouraged  by  the  Government.  Under 
the  stimulus  of  the  California  gold  discoveries,  the 
Government  changed  its  attitude  and  the  rush  of  gold 
seekers  to  Australia  in  the  early  50's  was  almost  as  great 
as  that  to  California.  As  a  result  of  these  discoveries 
the  annual  average  production  of  gold  increased  from 
about  $16,000,000  before  1850  to  nearly  $130,000,000 
between  1850  and  1870.  The  effect  upon  prices  may 
be  seen  in  the  price  tables  of  that  period. 

190.  Effect  of  California  gold. — Owing  to  the  fact 
that  the  monetary  circulation  in  this  country  during  that 
period  consisted  almost  entirely  of  bank  notes  based  on 
the  specie  reserve,  the  effect  of  the  new  gold  was  not 
so  pronounced  as  it  would  have  been  had  the  circulation 
consisted  entirely  of  specie.  The  gold  which  was  not 
required  for  circulation  in  California  and  which  was  not 
exported  was  used  to  strengthen  the  bank  reserves  and 
to  provide  for  the  increased  circulation  required  by  ex- 
panding industries.  The  tendency  of  the  sudden  ad- 
dition of  so  large  a  quantity  of  gold  to  the  world's 
supply  would  have  been  to  raise  prices  very  sharply,  had 
it  not  been  diverted  by  these  considerations. 

After  1870  the  annual  production  of  gold  declined 
steadily  for  twenty  years  and  had  more  serious  economic 
effects  than  the  increase  in  the  previous  twenty  years 
had  had.  The  declining  prices  which  it  occasioned  gave 


PRODUCTION  OF  PRECIOUS  METALS 


159 


rise  to  the  silver  question  which  agitated  the  world  for 
more  than  ten  years. 

191.  South  African  gold. — The  discovery  of  gold  in 
South  Africa  in  1889  and  in  the  Klondike  region  a  few 
years  later  brought  another  period  of  increased  gold 
production  and  a  rise  in  prices.     These  later  discoveries, 
combined  with  the  invention  of  new  processes  for  the 
extraction  of  gold,  have  given  the  science  of  money  an 
entirely  new  turn  within  the  last  ten  years. 

192.  Production  of  gold. — The  following  table  shows 
the  production  of  gold  and  silver  from  1492  to  1906: 1 


Gold. 


Silver. 


Total. 


Annual 
Average. 


Total. 


Annual 
Average. 


1500-1800 $2,371,000,000 

1801-1850 798,000,000 

1851-1870 2,596,000,000 

1871-1890 2,211,000,000 

1891-1900 2,101,000,000 

1901 262,000,000 

1902 295,000,000 

1903 325,000,000 

1904 358,000,000 

1905 379,000,000 

1906 400,242,100 

1907 410,436,000 


B  7,900,000  $4,863,000,000  $  16,210,000 
15,960,000  1,359,000,000  27,180,000 
129,800,000  879,000,000  43,900,000 
110,500,000  2,218,000,000  110,900,000 
210,100,000  2,089,000,000  208,900,000 

223,000,000 

215,000,000 

220,000,000 

226,000,000 

203,429,400 


193.  Origin  of  gold. — The  specific  gravity  of  gold 
is  very  high  and  is  exceeded  by  very  few  metals,  most 
of  which  are  exceedingly  scarce  and  valuable.  The 
theory  is  that  when  the  earth  was  thrown  off  from  the 
sun  it  was  in  a  gaseous  state.  The  gradual  cooling  of 
the  mass  and  the  dispersion  of  heat  permitted  the  forma- 
tion of  liquids  and  finally  of  solids.  The  first  solids 
to  be  formed  were  the  metals  of  the  highest  specific 
gravity  which  naturally  sank  to  the  center  of  the  earth 
through  the  gaseous  and  liquid  medium  by  the  force  of 
gravity.  As  the  cooling  process  continued  and  the 

i  Report  of  Director  of  the  Mint. 


160  MONEY  AND  BANKING 

earth  took  solid  form,  there  were  tremendous  upheavals 
of  the  surface.  The  enormous  heat  at  the  center 
formed  gases  which  in  escaping  threw  up  to  the  surface 
molten  matter  containing  gold  in  combination  with 
other  elements.  This  accounts  for  the  presence  of 
gold  in  mountainous  localities  where  the  upheavals  have 
been  severe  and  gives  rise  to  the  theory  that  at  the  center 
of  the  earth  gold  exists  in  large  quantities. 

194.  Sources  of  gold. — Until  within  recent   years 
practically  all  the  gold  produced  was  taken  from  gravel 
deposits.     The  free  gold  had  been  washed  out  of  the 
rock  by  erosion,  had  been  carried  down  in  the  streams 
and  because  of  its  great  weight  had  sunk  to  the  bottom 
of  the  stream  not  far  from  the  place  of  its  origin. 
These  small  particles  of  free  gold  were  separated  from 
the  mass  of  sand  and  gravel  by  the  simple  process  of 
"panning."     The   mass    was   mixed   with   water   and 
gradually  shaken  until  the  sand  had  been  washed  away, 
leaving  only  the  heavier  materials  behind.     The  fine 
particles  of  gold  were  separated  from  the  gravel  by 
means  of  quick  silver,  for  which  it  has  a  very  great 
affinity.     The  gold  was  then  separated  from  the  quick 
silver  by  filtering  the  latter  through  heavy  skins. 

195.  Improvements  on  placer  mining. — This  simple 
process  has  been  developed  by  the  use  of  machinery 
into  hydraulic  mining   and   "sluicing."     A   powerful 
head  of  water  is  obtained  by  diverting  a  stream  of  water 
from  the  mountains  by  conduits.     This  head  of  water 
produces  a  jet  which  is  directed  against  the  banks  of 
gold  bearing  earth,  tears  them  down  and  washes  them 
into  the  sluices.     In  these  sluices  are  built  artificial  ob- 
structions which  are  called  riffles  and  which  catch  the 
particles  of  gold  as  they  sink  to  the  bottom.     The  gold 


PRODUCTION  OF  PRECIOUS  METALS          161 

is  recovered  by  means  of  quick  silver  the  same  as  in 
panning. 

196.  Dredging. — Another  modern  method  is  that  of 
dredging.     Huge  dredgers  follow  the  beds  of  streams, 
scraping  up  in  huge  shovels  the  gold  bearing  earth, 
washing  it  out  inside  the  dredge  and  passing  out  the 
earth  and  water  behind  as  the  dredge  moves  on.     This 
wholesale  machine  method  of  placer  mining  has  re- 
duced the  cost  of  producing  gold  under  this  process 
from  $5.00  to  $8.00  per  ton  of  material  handled  to  1% 
to  8  cents. 

197.  Quartz   mining. — Other   processes   of    mining 
have  been  so  developed  that  at  the  present  time  the 
largest  portion  of  the  gold  produced  is  taken  from  the 
quartz.     Gold  occurs  in  the  rock  either  in  the  form  of 
free  milling  gold  which  requires  simply  to  be  separated 
from  the  rock  by  a  mechanical  process  or  it  occurs  in 
chemical     combination     with     other     elements     which 
requires  special  treatment  to  be  recovered.     The  quan- 
tity of   gold  which  can  be   produced  by  the  placer 
process  is  limited  because  the  beds  of  streams  can  be 
exhausted  very  soon.     The  opportunities  for  extracting 
the  gold  from  rock  formation  has  made  the  future  pro- 
duction of  gold  very  much  more  certain  and  reliable. 

In  extracting  gold  from  quartz  it  is  first  crushed  with 
powerful  machinery.  The  question  of  power  to  run  the 
ore  crushing  machines  has  been  a  very  serious  one  be- 
cause the  mines  have  usually  been  in  inaccessible  places 
remote  from  coal  deposits.  The  question  has  been 
solved  in  recent  years  by  the  development  of  electrical 
transmission  so  that  the  energy  in  the  mountain  streams 
can  be  converted  into  electricity  and  transmitted  hun- 
dreds of  miles  by  wire  to  the  mines.  If  the  ores  are 

VII— 11 


162  MONEY  AND  BANKING 

refractory,  containing  sulphur  and  other  troublesome 
elements,  they  must  first  be  roasted  to  expel  these  ele- 
ments in  the  form  of  gas.  After  roasting  chlorine  is 
added,  which  combines  with  the  gold,  forming  chloride 
of  gold.  Water  is  then  added  to  the  mass  and  the 
chloride  of  gold  leached  out.  The  pure  gold  is  pre- 
cipitated from  the  chloride  by  means  of  sulphate  of 
iron.  Cyanide  of  potassium  is  another  medium  used  in 
extracting  gold.  The  gold  is  precipitated  from  the 
solution  either  by  zinc  shavings  or  by  electrolysis.  In 
the  latter  process  gold  is  deposited  on  aluminum  plates 
from  which  it  can  be  easily  removed. 

These  processes  described  have  made  it  possible  to 
treat  ores  of  a  very  low  grade;  in  fact  it  has  been  pos- 
sible to  work  over  profitably  the  "tailings"  from  old 
placer  mines. 

198.  The  Comstock  Lode. — The  "Comstock  Lode,"  one  of  the 
most  famous  of  the  silver  mines,  was  also  a  large  producer  of 
gold.  Although  discovered  in  1858  by  a  Virginian  miner  named 
Finney,  the  lode  took  its  name  from  a  high-handed  and  reckless 
adventurer  named  Henry  Comstock.  It  was  gold  which  was 
first  taken  out,  and  before  mining  for  silver  was  systematized  a 
serious  battle  for  control  of  the  country  had  to  be  fought  with 
the  Indians  at  Pyramid  Lake.  Then  moved  across  the  scene 
Adolph  Sutro,  with  his  finally  successful  plan  for  a  tunnel  to 
carry  off  the  waters;  William  Sharon,  agent  of  the  Bank  of 
California  and  railway  promoter;  John  Mackay,  J.  G.  Fair, 
James  Flood,  and  William  0'Brien,  as  purchasers  of  the  Vir- 
ginia Consolidated  and  discoverers  of  the  "Big  Bonanza" ;  after 
1877  came  the  falling  off  in  the  product  and  the  gradual  decline 
of  the  mine.  Up  to  1880  the  total  product  of  the  Comstock 
mines  was  computed  at  $174,000,000  in  silver  and  $132,000,000 
in  gold.  The  highest  yield  was  $38,000,000  in  1876.  In  1880 
the  product  had  fallen  to  $5,100,000  and  in  1881  to  $1,000,000. 


PRODUCTION  OF  PRECIOUS  METALS          163 

The  Comstock  Lode  was  typical  of  the  highly  speculative  char- 
acter of  mining  enterprises.  Of  103  mining  enterprises  started 
up  to  1880,  only  six  proved  profitable.  They  yielded  a  product 
of  $115,900,000  for  an  expenditure  of  $18,300,000.  The  other 
ninety-seven  mines,  even  in  this  rich  district,  showed  a  loss  of 
$43,400,000.  While  cost  of  production  must  in  the  long  run 
influence  the  volume  of  the  precious  metals  taken  from  the 
mines,  the  speculative  character  of  mining  has  made  this  in- 
fluence difficult  to  trace  and  slow  in  its  operation.  It  is  prob- 
able that  the  total  stock  of  gold  and  silver  taken  from  the  earth 
has  been  extracted  at  a  cost  in  labor  several  times  the  value  of  the 
metal  obtained.  Where  a  few  have  obtained  rich  prizes,  many 
more  have  suffered  disappointment  and  ruin.  It  is  necessary 
not  merely  to  obtain  the  metals,  but  to  obtain  them  in  propor- 
tions which  compensate  for  the  labor  expended.  They  must,  as 
Hauser  expresses  it,  fall  within  the  "limit  of  exploitability." 
A  summary  of  the  economic  results  in  the  Californian  mines, 
made  by  Dr.  Reyer,  after  the  study  of  actual  conditions,  puts  the 
case  thus : 

"Even  though  the  dividends  in  particular  cases  are  large, 
they  by  no  means  cover  the  deficit  of  all  the  unprofitable  under- 
takings. In  fact,  the  production  of  gold  here,  as  in  Australia, 
has  always  yielded  a  net  loss.  This  may  be  explained  as  fol- 
lows: A  few  dozen  mines  produce  the  great  mass  of  gold. 
They  make  large  profits  and  determine  the  price.  Their  success 
attracts  capital  without  end  to  similar  undertakings;  these  are 
given  up  after  awhile,  and  the  money  is  returned  to  other  really 
productive  branches  of  industry.  But  the  temptation  from  the 
fortunate  gold  producers  continues,  and  causes  new  capital  con- 
stantly to  rush  to  its  destruction — the  same  phenomenon  that  is 
seen  in  games  of  chance.  A  few  win  a  great  deal;  hundreds 
lose  all  they  have.  The  business,  on  the  whole,  is  a  losing  one."  l 

i  C.  A.  Conant,  "  The  Principles  of  Money  and  Banking,"  pp.  92-3. 


CHAPTER  XI 

BIMETALLISM 

199.  Bimetallism  defined. — Bimetallism  is  a  mone- 
tary system  under  which  a  government  permits  any- 
body to  bring  gold  or  silver  to  the  mints  and  have  it 
coined  into  money,  which  shall  be  legal  tender  for  all 
purposes.     By  thus  permitting  the  coinage  of  metals 
without  restriction  the  relation  between  the  values  of 
coins  and  bullion  is  automatically  regulated.     A  demand 
for  money  will  tend  to  increase  its  value  compared  to 
bullion,  or  as  it  appears  to  the  public,  the  price  of  bul- 
lion falls  slightly.     Even  a  very  small  decline  would 
be  sufficient  to  induce  somebody  to  convert  bullion  into 
coins  through  the  mint  and  thus  re-establish  the  equilib- 
rium.    Prior  to  1816  countries  were  on  a  bimetallic 
basis,  admitting  to  their  mints  both  metals  at  a  fixed 
ratio.     In  this  country  the  first  coinage  laws  established 
a  double  standard;  the  dollar  was  to  be  composed  of 
either  371.25  grains  of  silver  or  24.75  grains  of  pure 
gold,  the  ratio  as  to  weight  being  fifteen  to  one. 

200.  Difficulties  of  bimetallism. — In  our  study  of 
the  standards  in  a  previous  chapter  we  have  seen  how 
the   difference  in  mint  ratios   between  the   different 
Governments  created  a  condition  which  has  made  it  im- 
possible to  keep  gold  and  silver  coins  in  circulation  con- 
currently.    In  fact  there  has  been  no  time  since  the 
founding  of  our  Government  when  it  could  have  been 
said  that  we  were  actually  upon  a  double  standard. 
The  truth  is  that  at  first  we  were  upon  a  silver  standard ; 

164 


BIMETALLISM  165 

then  from  1834  to  1862  we  were  upon  a  gold  stand- 
ard; then  from  1862  to  the  resumption  of  specie  pay- 
ments in  1879  we  were  upon  a  paper  money  standard; 
from  1873  to  1879  we  were  nominally  upon  a  single 
gold  standard  and  after  the  latter  date  actually  upon  a 
gold  standard. 

In  1816  England  adopted  a  single  gold  standard  and 
was  the  first  country  to  do  so.  The  other  countries  of 
Europe  and  the  United  States  continued  nominally 
upon  an  alternating  standard  until  the  70's. 

Before  the  beginning  of  the  nineteenth  century  bi- 
metallism in  Europe  was  practicable  because  at  that 
time  trade  had  not  been  developed  to  a  point  where  the 
different  ratios  in  the  different  countries  produced  any 
appreciable  flow  of  metals.  It  is  not  until  values  and 
prices  respond  readily  to  conditions  of  supply  and  de- 
mand and  until  there  is  sufficient  commercial  intercourse 
between  localities  to  equalize  values  that  difficulties  con- 
cerning the  standard  arise.  Prior  to  the  nineteenth  cen- 
tury there  were  so  many  interferences  with  the  natural 
play  of  supply  and  demand  that  the  values  were  mostly 
conventional  rather  than  competitive. 

201.  Advantages  of  bimetallism. — Notwithstanding 
that  practically  all  of  the  nations  of  the  earth  except- 
ing England  were  on  a  bimetallic  basis  before  1870,  the 
system  could  not  be  called  international  bimetallism  be- 
cause of  the  different  ratios  of  the  various  countries. 
Those  authorities  who  advocate  bimetallism  do  so  on  the 
ground  that  it  assures  a  more  stable  standard  than  either 
metal  if  used  exclusively.  It  is  argued  that  if  the  pro- 
duction of  either  metal  should  diminish  compared  with 
the  other  its  natural  rise  of  value  would  prevent  its 
being  taken  to  the  mint  for  coinage;  the  monetary  de- 
mand of  the  country  would  therefore  fall  upon  the 


166  MONEY  AND  BANKING 

other  metal  according  to  Gresham's  Law  which  is.  a 
statement  of  the  tendency  of  cheaper  money  to  drive 
out  the  dearer.  The  increased  demand  for  the  more 
abundant  metal  transferred  to  it  from  the  scarcer  metal 
would  tend  to  restore  the  equilibrium  between  the  two. 

For  instance,  if  under  the  conditions  just  mentioned 
it  had  been  gold  that  had  grown  scarcer  and  more 
valuable,  under  bimetallism  the  money  demand  would 
have  been  transferred  to  silver  until  its  bullion  value 
again  was  restored  to  an  equality  with  gold.  If  there 
had  been  a  single  gold  standard  under  the  same  cir- 
cumstances the  increased  value  of  gold  would  have  re- 
sulted in  an  appreciating  standard  and  a  consequent 
fall  in  prices.  Under  the  double  standard  there  could 
be  no  rise  of  general  prices  until  the  quantity  of  both 
gold  and  silver  had  altered  sufficiently  to  produce  this 
result. 

202.  International   bimetallism. — The   argument   of 
the  advocate  of  bimetallism  is  theoretically  sound  if  the 
system  is  adopted  by  all  countries  at  the  same  ratio.     If 
only  a  few  countries  have  a  bimetallic  standard,  the 
changes  in  the  quantity  of  the  production  of  either 
metal,  instead  of  throwing  increased  demand  upon  the 
other  metal,  would  tend  to  cause  an  export  of  the  scarcer 
and  an  import  of  the  more  abundant  metal  so  that  the 
system  would  not  only  fail  to  prevent  fluctuations  of 
prices,  but  would  bring  about  conditions  which  might 
lead  to  a  grave  crisis. 

203.  Disadvantages  to  commerce  of  different  stand- 
ard.— There  are  a  great  many  advantages  in  favor  of 
one  common  par  of  exchange  between  all  countries  hav- 
ing  extensive   commercial   relations.     The    difficulties 
encountered  when  the  standard  of  the  trading  countries 
is  different  is  apparent  in  the  silver  standard  countries 


BIMETALLISM  167 

to-day.  Importers  of  goods  from  silver  countries  are 
forced  to  become  speculators  in  silver.  If  they  force 
the  dealer  with  whom  they  contract  for  goods  to  quote 
prices  in  gold  they  simply  shift  the  speculative  risk  to 
his  shoulders.  It  is  axiomatic  that  wherever  there  is 
risk  and  uncertainty  in  making  contracts  and  doing  bus- 
iness the  volume  of  business  will  diminish  and  the  ex- 
pense of  doing  it  increase. 

More  serious  than  the  complications  in  importing  and 
exporting  merchandise  is  the  hindrance  which  different 
money  standards  place  in  the  way  of  the  international 
movement  of  capital.  Countries  on  a  silver  basis  when 
they  wish  to  place  a  loan  in  the  world's  money  centers 
are  obliged  to  promise  payment  in  gold;  since  the  in- 
come upon  which  they  depend  to  pay  interest  and  prin- 
cipal comes  to  them  in  silver,  they  are  likely  to  face 
grave  problems  at  any  time,  should  the  values  of  gold 
and  silver  standards  change.  Every  decline  in  the 
price  of  silver  in  the  world's  markets  means  to  the  silver 
standard  countries  an  appreciation  of  gold  and  greater 
difficulty  in  payment  of  debts. 

Private  enterprises  are  restricted  in  the  same  way. 
If  to  the  uncertainty  of  investment  in  the  new  country 
there  is  added  the  uncertainty  of  the  value  of  profits 
earned  on  capital  sent  to  those  countries,  the  invest- 
ments offered  to  attract  foreign  capital  must  be  more 
than  other  countries  need  to  offer.  The  silver  standard 
countries  are  laboring  under  a  handicap  in  competition 
with  gold  standard  countries. 

204.  Early  attempts  at  inflation. — After  1870  there 
was  continuous  decrease  in  the  annual  amount  of  gold 
produced  in  the  world,  the  result  of  which  was  to  check 
the  rise  of  prices  and  to  cause  them  to  decline.  In  the 
United  States  the  decline  of  prices  was  accentuated  bjr 


168  MONEY  AND  BANKING 

the  contraction  of  the  paper  currency  of  the  Civil  War 
Period.  This  decline  of  prices  was  very  unwelcome  to 
a  large  class  of  persons  who  attributed  it  to  a  scarcity 
of  money.  They  sought  to  improve  this  condition  by 
advocating  an  issue  of  additional  amounts  of  paper 
money.  The  agitation  took  shape  in  the  formation  of 
the  greenback  party  in  the  70's  which  was  strong 
enough  to  force  through  Congress  a  bill  providing  that 
the  retirement  of  the  greenbacks  should  be  suspended 
and  that  new  issues  should  be  put  out.  This  infla- 
tionists' bill  was  vetoed  by  President  Grant,  but  the  re- 
tirement of  the  greenbacks  which  had  gone  on  steadily 
for  ten  years  was  brought  to  an  end  and  the  quantity 
in  circulation  fixed  at  the  amount  at  which  it  now  stands, 
namely  $346,000,000. 

This  attempt  to  raise  prices  by  artificial  interference 
with  the  money  system  of  the  country  was  unsuccessful 
in  increasing  the  paper  money  of  the  country,  but  it  was 
the  parent  of  a  movement  which  sought  to  accomplish 
the  same  purpose  with  silver  instead  of  paper  as  the 
means.  But  before  we  discuss  the  silver  question  as 
such,  it  is  proper  to  study  the  conditions  which  led  up 
to  it. 

Simultaneously  with  the  decrease  in  the  production 
of  gold  and  the  increase  in  the  production  of  silver  the 
influence  of  England,  which  was  on  a  single  gold  stand- 
ard, was  no  doubt  the  cause  which  induced  the  bimetal- 
lic countries  to  demonetize  silver  at  this  time. 

205.  Demonetization  of  silver. — The  term  "demoneti- 
zation of  silver"  signifies  the  suspension  of  the  free 
coinage  of  that  metal.  When  the  mints  refuse  to  coin 
silver  bullion  into  money,  the  value  of  that  metal  is  no 
longer  sustained  by  the  demand  for  it  as  money. 
Henceforth  its  value  is  determined  the  same  as  that 


BIMETALLISM  169 

of  any  other  commodity  inasmuch  as  that  peculiar  de- 
mand which  before  distinguished  it  from  other  com- 
modities is  now  withdrawn.  Demonetization  does  not 
mean  that  the  metal  is  no  longer  to  be  used  as  money, 
for  silver  is  still  used  in  all  countries  which  have  de- 
monetized it.  The  silver  coins  in  a  gold  standard 
country  belong  to  the  class  of  credit  money  instead  of 
standard  money.  Their  value  has  no  relation  to  the 
quantity  of  metal  in  them,  any  more  than  the  paper  dol- 
lar is  affected  by  the  rise  and  fall  in  the  value  of  paper 
stock  of  which  it  is  composed.  In  making  and  issuing 
these  coins  the  Government  purchases  the  metal  in  the 
open  market  and  while  this  demand  will  have  an  effect 
upon  the  value  of  that  metal,  yet  it  is  perfectly  arti- 
ficial and  arbitrary. 

206.  The  Latin  Union. — Prior  to  1874  France  was 
the  most  important  bimetallic  country  in  the  world. 
After  1864  France  was  in  league  with  several  smaller 
countries  of  Europe;  France,  Italy,  Greece,  Belgium 
and  Switzerland.  This  league  was  the  Latin  Union, 
which  was  so  important  an  element  in  the  silver  discus- 
sions of  the  90's.  France  furnished  these  countries  with 
coins  of  gold  and  silver  so  that  for  monetary  purposes 
the  Union  might  be  considered  as  one  country.  The 
Latin  Union,  together  with  the  German  Empire  created 
a  demand  for  silver  which  maintained  its  value  for  some 
years  in  the  face  of  increased  production. 

In  1871  the  German  Empire  was  founded  and  the 
monetary  system  of  various  countries  composing  the 
empire  was  entirely  reconstructed.  The  free  coinage 
of  silver  was  suspended  and  supplies  of  gold  were  ac- 
cumulated to  maintain  the  value  of  all  the  credit  money 
of  the  Empire. 

France,  which  had  acted  as  an  equalizer  of  the  values 


170  MONEY  AND  BANKING 

of  gold  and  silver  in  Europe  up  to  this  time,  in  1874 
suspended  the  free  coinage  of  silver  in  response  to  the 
tendency  of  the  times. 

The  bimetallist  claims  that  the  close  correspondence  of  the 
market  ratio  with  the  French  coinage  ratio  was  not  fortuitous, 
but  was  due  to  the  fact  that  the  money  demand  for  the  two 
metals  was  kept  in  equilibrium  by  the  "bimetallic  law  of  France. 
Even  after  the  great  influx  of  gold  from  California  and  Aus- 
tralia in  the  fifties,  the  market  ratios  between  the  two  metals 
fluctuated  very  little.  In  the  year  1800  the  earth  was  producing 
fifty  ounces  of  silver  to  every  ounce  of  gold;  between  1852  and 
1858  it  produced  only  five  ounces  of  silver  for  every  ounce  of 
gold.  Despite  this  great  change  in  the  production-  ratio,  the 
value  ratio  of  the  two  metals  was  only  slightly  affected.  The 
increased  supply  of  gold  after  1850  undoubtedly  tended  to  lessen 
its  value,  and  for  ten  years  the  French  mint  was  busily  coining 
the  yellow  metal;  large  quantities  of  silver  were  exported  to 
India  and  the  East.  Between  1850  and  1865  there  happened 
in  France  exactly  what  the  theory  of  bimetallism  would  lead  us 
to  expect,  namely,  an  increased  coinage  of  the  cheaper  money 
metal,  gold,  and  a  lesser  use  of  the  other.  However,  France 
did  not  lose  all  of  her  silver  even  under  this  great  strain ;  and 
the  two  metals  of  the  world  retained  during  this  period  a  value 
ratio  remarkably  close  to  the  ratio  established  by  the  law  of 
France. 

The  monometallist  meets  this  argument  from  French  expe- 
rience in  various  ways.  He  first  makes  an  absolute  denial  of 
the  contention  that  the  so-called  "mint  demand"  has  any  effect 
whatever  on  the  value  of  the  metal.  No  mint,  he  says,  can  add 
the  slightest  value  to  any  metal;  a  mint  merely  puts  a  stamp 
upon  the  coin  to  signify  the  quantity  of  metal  it  contains,  but 
if  a  coin  is  hammered  on  an  anvil  its  value  is  not  lessened.  This 
is  true,  but  it  does  not  prove  that  the  value  of  a  metal  is  not 
due  partly  to  the  fact  that  the  mint  is  open  to  its  coinage.  Free 
coinage  makes  the  value  of  the  metal  uncoined  practically  the 


BIMETALLISM  171 

same  as  when  coined,  and  so  tends  to  cause  an  increased  demand 
for  it,  thereby  increasing  its  value.  A  mint  does  not  add  value  to 
the  metal,  but  the  demand  for  it,  growing  out  of  the  fact  that 
it  can  be  freely  minted  into  money,  does  give  it  a  value  which  it 
otherwise  would  not  possess.1 

207.  Demonetization  of  silver  by  the  United  States. — 
Because  the  United  States  was  on  a  paper  money  basis  at 
the  time  when  the  European  governments  were  chang- 
ing to  the  silver  standard,  the  effect  was  not  immediately 
felt.  In  1873  Congress  codified  the  coinage  laws  of  the 
country  and  accomplished  the  momentous  change  from  a 
double  standard  to  a  single  standard  without  exciting 
any  comment.  It  is  even  claimed  that  the  change  was 
effected  by  the  accident  of  leaving  out  unintentionally 
the  name  of  the  silver  dollar  from  the  list  of  coins. 

The  Act  of  1873  declares  that  the  gold  dollar  of  25.8  grains 
standard  "shall  be  the  unit  of  value."  After  enumerating  the 
various  gold  coins  that  may  be  minted,  it  provides  for  the  free 
coinage  of  silver  "trade  dollars,"  to  contain  420  grains  standard 
silver,  and  for  the  coinage  by  the  Government  of  subsidiary  silver 
coins,  all  these  to  be  legal  tender  only  for  amounts  not  exceeding 
$5.00.  The  old  silver  dollars  of  412.5  grains  standard  is  not 
mentioned;  its  coinage,  therefore,  was  prohibited  by  the  follow- 
ing: "That  no  coins,  either  of  gold,  silver  or  minor  coinage, 
shall  hereafter  be  issued  from  the  mint  other  than  those  of  the 
denominations,  standards  and  weights  herein  set  forth."2 

When  the  redemption  of  Government  paper  at  par 
was  resumed  in  1879  it  might  have  been  preferable 
to  take  silver  to  the  mint  for  coinage,  but  it  was 
found  that  the  privilege  had  been  withdrawn,  and  the 
owner  of  silver  was  forced  to  sell  the  metal  in  the  open 

1  Johnson,  "  Money  and  Currency,"  pp.  225-6. 

2  Id.,  p.  242,  note  1. 


172  MONEY  AND  BANKING 

market  the  same  as  any  other  commodity.  At  the  time 
these  changes  were  taking  place  with  reference  to  the 
standard  the  price  of  silver  bullion  was  $1.298,  at  which 
figure  the  quantity  of  silver  in  the  dollar  was  worth 
slightly  more  than  the  gold  equivalent.  The  curtail- 
ment of  the  demands  of  European  countries  for  silver 
as  money  combined  with  the  increased  production,  and 
the  quantities  thrown  on  the  market  by  France  and 
Germany  in  exchange  for  gold  caused  a  decline  in  the 
price  of  silver  to  set  in,  which  continued  steadily  year 
after  year  until  in  1902  it  stood  at  52.7  cents  per  ounce, 
less  than  half  its  value  thirty  years  before. 

208.  The    silver    purchase    acts. — The    fall    in    the 
price  of  silver  stimulated  the  silver  mining  interests  in 
this  country  to  activity.     They  were  successful  in  1878 
in  getting  passed  through  Congress  the  Bland- Allison 
Act,  which  required  the  Secretary  of  the  Treasury  to 
purchase  each  month  in  the  open  market  two  million 
ounces  of  silver  which  should  be  coined  into  silver  dol- 
lars.    In  this  way  the  interests  sought  to  substitute  an 
artificial  demand  for  silver  which  would  have  been  nat- 
ural if  free  coinage  had  not  been  suspended  five  years 
before. 

The  effect  of  these  purchases  was  not  sufficient  to 
counteract  the  tendency  of  the  constantly  increasing 
supply  and  in  1890  the  Sherman  Act  passed,  which 
required  the  Secretary  of  the  Treasury  to  purchase  each 
month  four  and  a  half  million  ounces  of  silver  instead 
of  two  million  and  authorized  the  issue  of  treasury  notes 
of  1890  to  pay  for  the  silver.  The  effect  of  this  act 
was  to  inflate  the  currency  by  the  addition  of  both  silver 
and  paper  credit  money — practically  an  accomplishment 
of  what  the  greenback  party  had  failed  to  do  in  1875. 

209.  Sherman  Act  one  of  the  causes  of  the  panic 


BIMETALLISM  173 

of  1893. — There  is  a  very  general  agreement  among 
authorities  that  the  Sherman  Act  of  1890  was  one  of 
the  most  important  causes  of  the  panic  of  1893.  The 
act  came  at  a  time  when  speculation  had  already  forced 
prices  to  an  artificial  level  and  led  to  great  over-expan- 
sion of  credit.  The  silver  purchase  law  accelerated 
this  tendency,  while  at  the  same  time  it  undermined  the 
foundations  of  credit.  Gold  exports  began  and  con- 
tinued until  1896.  The  earlier  exports  of  gold  came 
from  the  vaults  of  the  banks.  Soon  the  banks  became 
unwilling  to  permit  their  gold  reserves  to  be  diminished 
in  this  way  and  the  gold  was  secured  by  exporters  from 
the  Government  treasury.  In  the  Resumption  Act  of 
1879  the  Government  had  pledged  itself  to  redeem  the 
greenbacks  in  gold  whenever  presented.  Accordingly 
it  was  a  very  simple  matter  for  exporters  desiring  gold 
to  take  greenbacks  to  the  treasury  and  demand  gold  for 
them.  This  demand  grew  steadily  and  finally  became 
so  large  as  to  waken  the  apprehension  of  the  Adminis- 
tration. 

When  President  Cleveland  was  inaugurated  for  the 
second  time  in  1892  he  found  himself  face  to  face  with 
an  extremely  serious  problem.  The  unwise  acts  in 
favor  of  silver  were  rapidly  putting  the  Government  in 
a  position  where  it  could  not  keep  its  promises  or  main- 
tain the  foundations  of  credit,  already  overburdened  at 
this  time. 

The  Sherman  Act  of  1890  had  been  put  through 
Congress  by  a  log-rolling  scheme  by  which  the  pro- 
moters of  the  McKinley  Tariff  Bill  secured  votes  by 
promising  to  vote  for  the  Silver  Bill.  This  alliance  of 
the  Republican  party  leaders  with  the  silver  interests 
proved  in  later  years  to  be  very  embarrassing  and  re- 
quired the  greatest  ingenuity  to  explain  away. 


174  MONEY  AND  BANKING 

The  crisis  which  arrived  in  1893  was  the  legitimate 
effect  of  the  monetary  and  tariff  vagaries  of  the  pre- 
ceding years.  There  is  no  doubt  that  the  crisis  would 
have  arrived  but  it  is  likely  that  it  would  have  been  much 
less  severe  and  that  the  period  of  depression  following 
!  it  would  have  been  much  shorter,  had  the  legislation  of 
the  preceding  years  been  more  scientific. 

The  distress  and  suffering  caused  by  the  crisis  and 
depression  created  great  discontent  among  the  people 
and  stimulated  a  search  for  the  causes,  so  that  the  blame 
might  be  properly  placed. 

210.  Silver  would  not  circulate. — It  is  incredible 
that  the  panic  of  1893  should  have  been  attributed  to 
lack  of  sufficient  currency  in  the  country,  when  the  real 
difficulty  was  redundancy  of  certain  kinds  of  currency. 
The  coinage  of  the  new  silver  dollars  under  the  silver 
purchasing  acts  of  1878  and  1890  had  piled  up  in  the 
treasury  amounts  of  currency  with  which  the  officers  did 
not  know  how  to  deal.  The  coins  were  so  bulky  and  in- 
convenient that  the  people  refused  to  take  them  in  any 
large  quantity.  Whenever  they  were  paid  out  they 
very  soon  returned  to  the  treasury  in  payments  made  to 
the  Government.  So  long  as  the  Government  had  a 
surplus  of  revenue  sufficient  to  meet  all  expenditures 
including  the  enforced  purchase  of  silver  bullion,  there 
was  no  immediate  cause  for  apprehension. 

The  prosperity  and  good  crops  of  the  years  1879-80 
created  a  demand  for  additional  circulation  in  the 
western  states  and  the  silver  dollars  found  an  outlet 
there. 

The  movement  was  accelerated  by  an  offer  on  the  part  of  the 
Treasury  to  buy  silver  certificates  in  the  west  and  south  in  ex- 
change for  gold  deposited  in  the  sub-treasury  in  New  York. 
Whenever  the  rate  of  exchange  was  in  favor  of  the  west  and 


BIMETALLISM  175 

south,  the  person  desiring  to  make  remittance  could  save  express 
charges  by  accepting  the  Government's  offer.  In  this  way  the 
surplus  silver  in  the  Treasury  was  worked  off  for  the  time 
being.1 

A  minor  commercial  crisis  occurred  in  1884,  the  effect 
of  which  was  to  cause  a  decline  in  the  public  revenues. 
In  addition  to  this  shrinkage  the  percentage  of  the 
receipts  paid  in  gold  diminished  from  75  per  cent  to 
36  per  cent  of  the  whole;  the  silver  receipts  rose  from 
17  per  cent  to  36  per  cent;  and  the  balance  of  28  per 
cent  was  received  in  greenbacks. 

211.  Attitude  of  banks  toward  silver. — The  banks  at 
this  time  had  begun  to  discriminate  against  the  silver 
certificates.     The  clearing  houses  had  made  a  rule  that 
they  were  not  to  be  received  in  settlement  of  balances. 
However,  after  Congress  had  passed  a  law  forbidding 
national  banks  to  become  members  of  clearing  houses 
which  did  not  receive  the  silver  certificates,  the  rule  was 
rescinded,   but  the   banks   voluntarily   agreed   among 
themselves  not  to  make  payments  in  silver  certificates. 
The  sub-treasury  of  New  York  was  a  member  of  the 
clearing  house  and  at  this  time  in  order  to  prevent  the 
payment  of  its  balances  in  certificates  the  New  York 
banks  voluntarily  turned  into  the  treasury  $6,000,000. 

212.  Silver  certificates. — To  Secretary  Manning  be- 
longs the  credit  for  having  postponed  for  several  years 
the  worst  effects  of  the  bad  financial  legislation.     Up 
to  1885  the  greenbacks  had  been  issued  in  denomina- 
tions  below  $5.     After  that   date  the   Secretary  or- 
dered that  none  should  be  issued  under  $5.     In  the  next 
year  he  procured  from  Congress  the  authority  to  issue 
silver  certificates  in  denominations  of  $1,  $2  and  $5. 

This  device  solved  the  problem  of  keeping  silver  in 

»  White,  "  Money  and  Banking,"  p.  172. 


176  MONEY  AND  BANKING 

circulation  by  proxy,  but  it  did  not  cure  the  funda- 
mental trouble,  the  serious  consequences  of  which  cul- 
minated eight  years  later. 

The  secretary  was  helped  out  of  his  dilemma  by  a 
favorable  condition  at  this  time.  Sharp  advances  in 
price  of  Government  bonds  had  reduced  the  profit  in 
the  issue  of  national  bank  notes  and  a  considerable  con- 
traction in  their  volume  occurred.  The  vacancy  in  the 
circulation  left  by  the  retirement  of  a  number  of  the 
national  bank  notes  was  filled  by  the  silver  certificates 
and  they  were  restrained  from  returning  to  the  treasury 
for  redemption  or  in  payment  of  Government  dues. 

When  the  silver  coinage  act  was  passed  in  1878,  its  opponents 
predicted  that  sooner  or  later  it  would  cause  a  financial  panic. 
They  said  that,  since  the  metallic  value  of  the  silver  dollars  was 
not  equal  to  the  face  value,  they  were  simply  a  new  kind  of  fiat 
money,  and  that,  whenever  they  should  become  redundant,  they 
would  act  like  any  other  fiat  money — like  the  greenbacks  at  the 
beginning  of  the  war,  for  example.  There  would  then  be  a 
change  in  the  standard  of  value,  if  the  coinage  were  continued. 
This  was  a  true  prophecy,  but  the  fulfillment  was  delayed  by  the 
shrinkage  in  the  national  bank  circulation  and  by  the  retire- 
ment of  small  greenbacks,  which  created  a  vacuum  for  the  new 
silver  to  fill.  But  this  was  a  silent  operation.  The  public  could 
not  understand  it,  and  so,  as  the  years  rolled  on  and  no  harm 
came  from  the  coining  of  silver  dollars,  the  predictions  of  panic 
fell  under  popular  ridicule.1 

213.  Currency  situation  in  1890. — In  1890  there  was 
outstanding  in  circulation  three  varieties  of  money  de- 
pending for  their  value  upon  the  credit  backing  of  the 
Government.  The  silver  dollars,  the  treasury  notes 
and  the  greenbacks  all  rested  upon  the  Government's 
pledge  to  redeem  them  upon  demand  in  gold.  At  this 

i  White,  "  Money  and  Banking,"  p.  175. 


BIMETALLISM  177 

time  the  law  required  no  particular  gold  reserve,  but 
custom  had  established  the  amount  of  $100,000,000. 
Even  if  the  gold  were  maintained  at  a  minimum  figure 
the  constant  increase  in  the  volume  of  credit  money  due 
to  the  silver  purchases  lessened  the  reserve  percentage. 
This  might  not  have  led  to  serious  consequences  of  it- 
self, but  after  1890  other  natural  and  inevitable  effects 
of  the  redundant  issue  of  credit  money  began  to  be  per- 
ceived. Gold  exports  began  and  continued  until  the 
gold  reserve  had  been  so  depleted  as  to  cause  grave 
alarm  for  the  maintenance  of  government  credit. 

The  great  danger  of  a  sudden  demand  for  one  kind 
of  money  over  another  comes  from  the  cumulative  effect. 
When  there  was  danger  of  gold  becoming  scarce,  every- 
body began  to  desire  it  before  other  forms  of  money, 
and  thus  accelerated  the  withdrawal  of  gold  from  the 
treasury  after  the  banks  had  begun  to  refuse  to  make 
payments  in  that  metal. 

214.  The  treasury  gold  reserve. — As  doubt  increased 
as  to  whether  the  Government  would  be  able  to  redeem 
the  credit  money  on  demand  in  gold,  the  banks  began 
to  convert  their  reserves  into  gold  as  rapidly  as  possible. 

Gold  exports  were  resumed  in  1892.  In  November  of  that 
year  the  gold  in  the  Treasury  had  fallen  from  $185,000,000  (in 
August,  1890)  to  $124,000,000  and  was  still  declining.  Secre- 
tary Foster  was  much  depressed.  When  he  came  to  New  York 
to  speak  at  a  dinner  of  the  Chamber  of  Commerce,  he  said,  among 
other  things,  that  the  Government  intended  to  maintain  gold 
payments,  even  if  it  became  necessary  to  sell  government  bonds 
for  the  purpose.  This  was  an  admission  on  his  part  that  gold 
payments  could  not  be  continued  without  resorting  to  extraor- 
dinary means.  Probably  Mr.  Foster  made  this  speech  in  order 
to  test  public  sentiment  and  to  find  out  whether  he  would  be 
sustained  in  issuing  government  bonds  in  time  of  peace.  There 
VJI-13 


178  MONEY  AND  BANKING 

had  been  no  increase  of  the  bonded  debt  since  the  close  of  the 
Civil  War,  and  some  persons  in  high  place  denied  that  there  was 
any  legal  authority  to  issue  new  bonds.  Apparently  Mr.  Foster 
was  satisfied  by  the  applause  with  which  his  announced  purposes 
was  received  by  his  hearers  and  by  the  press,  for  shortly  after- 
wards he  issued  an  order  to  the  Bureau  of  Engraving  and  Print- 
ing to  prepare  new  bonds.  This  order  was  dated  February  20, 
1893,  and  Mr.  Foster  was  to  go  out  of  office  on  the  4th  of 
March.  Naturally,  he  preferred  to  put  upon  his  successor  the 
onus  of  issuing  the  bonds  if  he  could.  So  he  came  to  New  York 
and  persuaded  the  banks  to  give  him  a  few  millions  of  gold  in 
exchange  for  legal  tender  notes,  enough  to  carry  him  along  till 
the  4th  of  March.  This  enabled  him  to  glide  out  of  office  leav- 
ing the  $100,000,000  redemption  fund  intact,  but  with  only 
$982,410  gold  in  excess  of  that  sum  and  with  the  penumbra  of 
a  deficit  in  full  view.1 

215.  Repeal  of  the  Sherman  rAct. — Upon  Secretary 
Carlisle  fell  the  burden  which  the  Republican  adminis- 
tration had  managed  to  avoid.  President  Cleveland 
announced  that  the  redemption  of  Government  credit 
money  in  gold  would  be  continued  under  all  circum- 
stances. And  early  in  the  summer  he  called  a  special 
session  of  Congress  which  repealed  the  silver  purchasing 
clause  of  the  Sherman  Act  of  1890.  Just  at  this  time 
the  mints  of  India  were  closed  to  the  free  coinage  of 
silver,  which  caused  the  price  of  that  metal  to  fall  from 
$.82  to  $.67  per  ounce  within  three  days.  These  events 
inaugurated  the  panic  of  1893. 

The  repeal  of  the  Sherman  Act  came  too  late  to  save 
the  situation.  The  gold  reserve  continued  to  decline 
until  it  had  reached  $67,000,000  in  January  of  the  fol- 
lowing year.  The  difficulty  was  aggravated  by  the 

i  White,  "  Money  and  Banking,"  p.  176. 


BIMETALLISM  179 

sharp  decline  in  government  revenues  which  the  shrink- 
age of  imports  and  consequently  the  duties  collected 
thereon  brought  about. 

Congress  at  this  time  was  Republican.  President 
Cleveland  used  his  utmost  endeavor  to  get  legislation 
authorizing  him  to  replenish  and  maintain  the  gold  re- 
serve by  means  of  bonds  issued.  The  partisanship  of 
the  Republican  party  in  this  crisis  was  greater  than  its 
patriotism.  It  seemed  to  be  willing  to  permit  the  coun- 
try to  suffer  and  its  credit  to  be  ruined  if  only  the 
prestige  of  the  Democratic  party  could  be  injured,  not- 
withstanding the  fact  that  the  cause  of  the  crisis  could 
be  traced  to  legislation  passed  by  the  Republicans  them- 
selves. That  party  relied  upon  the  ignorance  of  the 
public  and  upon  their  power  to  inculcate  the  belief  that 
the  Democratic  party  was  responsible  for  the  panic. 
The  opprobrium  which  the  President  was  compelled  to 
endure  in  the  next  two  or  three  years  proved  that  the 
Republicans  had  been  successful  in  their  calculations. 

216.  Authority  to  issue  bonds. — Failing  to  get  the 
consent  of  Congress  to  the  issue  of  bonds  the  President 
was  obliged  to  fall  back  upon  the  Resumption  Act  of 
1875  which  provided  power  to  sell  bonds  for  the  pur- 
pose of  redeeming  the  greenbacks.     The  purpose  of 
this  law  was  to  give  the  Secretary  the  means  by  which 
the  greenbacks  could  be  redeemed  and  there  was  grave 
doubt  as  to  the  propriety  of  using  it  for  the  present 
purpose.     President    Cleveland    was    strong    enough, 
however,  to  put  the  needs  of  the  country  above  legal 
technicalities  and  a  bond  issue  was  authorized. 

217.  Successive  issues  of  bonds. — By  means  of  this 
bond  issue  the  gold  reserve  was  brought  up  above  the 
$100,000,000  limit,  but  the  same  causes  which  had  be- 


180  MONEY  AND  BANKING 

fore  depleted  it  were  still  operative  and  it  was  again 
reduced  by  withdrawals  to  $52,000,000  within  six 
months. 

Another  bond  issue  of  $50,000,000  in  November, 
1894,  failed  to  help  the  situation.  Faith  in  the  ability 
of  the  United  States  to  maintain  its  credit  grew  weaker 
and  weaker. 

The  withdrawals  of  gold  for  export,  however,  had  a 
limit,  but  at  this  time  evidence  appeared  showing  that 
much  gold  was  being  hoarded.  This  was  an  ominous 
sign,  for  if  this  hoarding  went  on  with  cumulative  ef- 
fect there  was  no  limit  to  the  demands  which  might  be 
made  upon  the  treasury. 

218.  The  Belmont-Morgan  Syndicate. — At  this  crisis 
President  Cleveland  took  an  action  which  for  the  time 
being,  made  him  more  unpopular  than  any  President 
who  had  preceded  him.  Perceiving  clearly  that  bonds 
sold  in  this  country  simply  created  an  endless  chain, 
the  final  result  of  which  was  to  increase  the  bonded 
indebtedness  of  the  Government  without  permanently 
relieving  the  situation,  he  appealed  to  the  syndicate  of 
New  York  bankers.  The  arrangement  made  with 
Belmont-Morgan  was  that  they  should  provide  the 
treasuiy  with  gold  to  the  amount  of  $65,117,500,  half 
of  which  at  least  should  be  brought  from  Europe  and 
that  the  syndicate  should  do  all  in  its  power  to  protect 
the  gold  reserve  in  the  treasury. 

It  may  seem  strange  that  the  syndicate  of  bankers 
had  more  power  to  produce  a  certain  result  than  the 
Government  of  the  United  States  in  time  of  peace. 
The  Government  at  this  time,  however,  was  in  a  con- 
dition similar  to  that  of  a  strong  man  who  has  indulged 
in  a  debauch  which  has  paralyzed  all  his  powers.  The 


BIMETALLISM  181 

Government  had  abused  its  credit  by  the  issue  of  prom- 
ises to  pay  gold  until  it  was  in  immediate  danger  of 
collapse. 

The  gold  which  the  syndicate  agreed  to  furnish  to 
the  treasury  was  paid  for  with  4  per  cent  thirty-year 
bonds  at  104.49,  the  rate  of  yield  of  which  would 
figure  3%  per  cent  per  annum.  The  syndicate  made 
a  proposition  to  the  Government  that  if  the  bonds  were 
made  payable  in  gold  they  would  accept  them  at  a  price 
equivalent  to  3  per  cent  instead  of  3%  per  cent  yield. 
The  saving  to  the  Government  on  this  proposition  would 
have  amounted  to  over  $16,000,000  during  the  life  of 
the  bonds,  but  the  narrow  mindedness  of  Congress  and 
their  petty  satisfaction  in  embarrassing  the  President 
caused  them  to  reject  the  proposition.  The  syndicate 
stopped  the  exports  of  gold  by  offering  to  sell  ex- 
change at  a  price  which  would  make  it  unprofitable  to 
ship  gold  out  of  the  country.  By  keeping  the  maxi- 
mum price  of  sterling  exchange  below  the  export  point 
they  protected  the  gold  in  this  country  and  importa- 
tions of  gold  from  their  European  correspondents 
soon  brought  up  the  reserve  above  the  one  hundred  mil- 
lion dollar  mark. 

There  were  not  wanting  people  at  this  time  to  charge 
that  the  financiers  had  brought  about  the  crisis  and  the 
shortage  of  gold  for  the  sake  of  their  own  profit.  It 
was  forgotten  that  the  losses  which  members  of  the 
syndicate  as  well  as  all  the  financial  interests  of  the 
country  suffered  by  the  panic  of  1893  were  hundreds 
of  times  greater  than  the  profit  they  derived  from  this 
transaction.  It  was  forgotten  that  when  the  syndicate 
made  this  agreement  they  were  taking  the  greatest  risk 
in  being  able  to  carry  it  out.  And  if  there  had  not  been 


182  MONEY  AND  BANKING 

an  improvement  in  conditions,  their  losses  in  attempt- 
ing to  keep  sterling  exchange  below  the  export  point, 
might  have  exceeded  greatly  the  profits. 

The  episode  which  began  with  the  silver  purchased 
and  ended  with  the  syndicate  agreement  ought  to  teach 
a  lesson  for  all  time  that  the  Government  is  not  all- 
powerful  and  that  its  credit  may  be  endangered  the 
same  as  that  of  a  private  individual  or  corporation. 
To  show  how  little  the  lesson  had  really  been  appre- 
ciated it  is  sufficient  to  recall  that  one  of  the  strong 
arguments  of  the  free  silver  party  within  a  year  or  two 
was  that  the  Government  is  big  enough  to  absorb  all  the 
silver  in  the  world  without  feeling  it. 

219.  Silver  question. — It  must  be  remembered  that 
during  the  trying  times  of  President  Cleveland's  sec- 
ond administration  the  Republican  party  sympathized 
with  the  Silver  party  and  were  under  obligations  to 
them  for  assistance  in  passing  the  McKinley  tariff  bill, 
which  at  that  time  was  more  important  to  the  interests 
represented  by  the  Republican  party  than  the  money 
question.  The  panic  of  1893  and  the  depression  fol- 
lowing, so  far  from  teaching  the  public  a  wholesome 
lesson  in  the  elements  of  finance,  gave  the  inflationists 
an  opportunity  to  press  their  demand  for  more  cur- 
rency. 

The  average  man  in  1894  could  not  be  brought  to 
believe  that  the  business  depression  was  caused  by  a 
redundancy  rather  than  a  scarcity  of  money.  From  his 
point  of  view  money  was  very  scarce  and  hard  to  get. 
He  could  not  see  that  it  was  a  contraction  of  credit 
and  the  lack  of  confidence  in  future  values  that  had  laid 
a  heavy  hand  on  all  business  enterprises.  He  readily 
fell  in  with  the  doctrine  that  more  money  made  higher 
prices  and  that  higher  prices  would  bring  prosperity. 


BIMETALLISM  188 

If  a  proposition  had  been  made  to  change  the  bushel 
from  thirty-two  quarts  to  thirty  quarts  in  order  to 
increase  the  supply  of  potatoes  in  the  country  its  ab- 
surdity would  have  been  readily  perceived.  The  same 
proposition  with  reference  to  the  dollar  was  readily 
accepted. 

There  can  be  no  doubt  that  the  decline  of  prices  had 
been  caused  by  the  decrease  in  the  production  of  gold 
relatively  to  the  increased  volume  of  business  in  the 
world  after  1870  and  also  to  the  increased  demand 
placed  upon  the  gold  in  existence  by  the  demonetization 
of  silver.  The  devotees  of  international  bimetalism 
were  quite  right  in  believing  that  concerted  action  by 
the  governments  of  the  world  in  restoring  silver  to  its 
status  as  standard  money  would  lighten  the  demand 
upon  gold  and  cause  a  general  rise  of  prices.  The 
futility  of  expecting  any  such  action,  however,  was 
apparent  after  the  failure  of  the  International  Mone- 
tary Congress  of  1878. 

220.  Origin  of  the  Free  Silver  movement. — The 
purchasers  of  silver  bullion  who  had  a  selfish  interest 
in  attempting  to  raise  the  price  of  silver  found  a  pow- 
erful alliance  with  the  western  farmers.  This  class  of 
men  had  gone  into  the  country  west  of  the  Mississippi 
and  had  taken  up  as  much  land  as  they  could  under 
the  easy  terms  of  the  Homestead  act.  As  a  rule  these 
men  were  lacking  in  capital  to  begin  farming  opera- 
tions. They  were  compelled  to  borrow  funds  at  exor- 
bitant rates  of  interest  by  mortgaging  their  real  estate. 
Under  the  high  prices  of  wheat,  which  at  that  time  was 
the  one  crop  which  the  farmer  was  sure  of  being  able 
to  turn  into  cash,  he  figured  that  he  would  easily  meet 
the  interest  on  the  mortgage  and  lay  aside  each  year 
enough  to  pay  off  the  mortgage  at  maturity.  As  wheat 


184  MONEY  AND  BANKING 

declined  in  price  from  $2  per  bushel  to  $.50  while  the 
amounts  payable  on  the  mortgage  remained  the  same 
as  before,  the  burden  of  meeting  these  payments  be- 
came greater  and  greater  until  foreclosure  and  bank- 
ruptcy seemed  inevitable.  Under  such  depressing  con- 
ditions the  farmers  were  ready  to  accept  the  most 
plausible  explanation  presented  by  the  silver  interests. 
The  only  possible  remedy  seemed  to  be  a  rise  of  prices, 
especially  in  wheat. 

221.  Arguments  for  free  silver. — There  does  not  seem 
to  be  any  way  to  deny  that  an  increase  in  the  quantity 
of  standard  money  would  raise  prices,  but  the  proposi- 
tion to  swell  the  volume  of  standard  money  by  diluting 
it  with  silver  under  the  world-wide  conditions  prevail- 
ing at  that  time  would  probably  have  brought  conditions 
to  the  country  as  a  whole  which  were  much  worse  than 
they  were  enduring,  although  probably  the  mortgage- 
burdened  farmer  as  a  rule  would  have  been  helped  tem- 
porarily. 

The  farmer  was  also  invited  to  consider  how  difficult  the  pay- 
ment of  the  national  debt  was  becoming.  At  the  end  of  the 
Civil  War  it  amounted  to  $2,800,000,000  and  might  then  have 
been  paid  with  1,400,000,000  bushels  of  wheat,  which  was  worth 
at  that  time  $2.00  a  bushel.  This  national  debt  was  mainly  in 
the  form  of  bonds  which  the  Government  had  sold  for  greenbacks 
worth  only  fifty  cents  on  the  dollar  in  gold.  Owing  to  the  con- 
spiracy among  the  "gold  bugs"  of  the  east,  Congress  had  en- 
forced the  payment  of  these  bonds  in  gold,  so  that  the  Govern- 
ment was  paying  back  to  its  creditors  twice  as  much  as  it  had 
received. 

But  this  was  not  all,  for  that  same  conspiracy  had  increased 
the  value  of  gold  itself.  The  real  wealth  of  the  country  lies  in 
such  commodities  as  wheat.  The  gold  payments  already  made 
on  account  of  the  national  debt  had  been  sufficient  to  buy,  at  the 


BIMETALLISM  185 

prices  prevailing  when  the  payments  were  made,  4,000,000,000 
bushels  of  wheat,  an  amount  nearly  three  times  as  great  as  the 
original  debt  when  figured  in  wheat.  Nevertheless  the  debt  had 
not  been  paid,  for  there  remained  still  due  $1,500,000,000, 
which  represented  at  the  then  low  price  of  wheat,  3,000,000,000 
bushels,  or  over  twice  as  much  as  was  owed  in  the  beginning. 

It  is  not  strange  that  this  reasoning,  which  made  the  debt  in 
goods  grow  in  spite  of  the  fact  that  it  had  been  twice  paid,  should 
have  a  powerful  influence  upon  the  agricultural  population. 
Wheat  was  not  the  only  agricultural  product  that  had  fallen  in 
price.  The  price  of  almost  everything  that  the  farmer  could 
raise  for  the  market  had  been  cut  in  two.  The  advocates  of 
silver  held  that  its  free  coinage  would  cause  a  tendency  of  prices 
upward,  and  that  this  would  atone  for  the  injustice  worked  by  the 
fall  of  prices  after  1873.  It  was  only  fair,  they  argued,  that 
the  debtor  who  had  been  robbed  should  now  get  back  some  of  his 
due.1 

222.  Argument  to  the  workingman. — While  the  low 
price  of  wheat  and  other  food  stuffs  had  placed  the 
farmer  in  such  a  predicament  it  might  seem  that  there 
was  a  corresponding  benefit  to  all  consumers,  especially 
the  laboring  class,  the  largest  percentage  of  whose  in- 
come must  be  spent  for  food.  The  advantage  to  this 
class,  however,  had  been  negatived  by  the  crisis  of  1893 
which  threw  so  many  out  of  employment.  They  could 
not  be  brought  to  consider  that  cheap  food  was  a  great 
advantage  when  their  incomes  were  so  precarious. 
Even  the  statisticians  proved  that  the  relative  rate  of 
wages  in  proportion  to  the  cost  of  living  had  increased 
greatly  since  1873  it  was  not  sufficient  to  offset  the  lack 
of  employment  during  the  business  depression.  To  this 
class  it  appeared  also  that  the  difficulty  lay  in  the 
scarcity  of  money;  free  silver  meant  more  money  in 

i  Johnson,  "  Money  and  Currency,"  pp.  244-5. 


186  MONEY  AND  BANKING 

circulation  and  that  was  obviously  the  remedy  for  the 
distress. 

223.  Arguments  of  advocates  of  gold. — While  many 
of  the  arguments  of  the  free  silver  leaders  were  un- 
scientific and  calculated  to  appeal  to  popular  prejudices 
and  ignorance,  many  of  the  arguments  of  their  oppo- 
nents were  no  better.     The  advocates  of  gold  made 
some  strange  deductions  from  the  argument  that  with 
the  free  coinage  of  silver  the  country  would  be  placed 
upon  a  silver  standard  along  with  Mexico  and  China. 
They  tried  to  frighten  the  workingman  by  stating  that 
his  wages  would  be  paid  in  "50-cent  dollars."     They 
prophesied  a  deluge  of  silver  from  all  quarters  of  the 
world  without  perceiving  that  the  latter  event  would  be 
absolutely    inconsistent    with    50-cent    dollars.     There 
would  be  no  inducement  for  the  importation  of  silver 
from  abroad  unless  its  value  was  raised  in  this  country. 
If  Congress  passed  a  law  authorizing  the  coinage  of 
50  cents  worth  of  silver  into  legal  tender  which  would 
perform  the  same  money  work  as  $1  worth  of  gold, 
it  is  not  difficult  to  see  that  there  would  at  once  arise 
a  great  demand  for  silver.     Nobody  would  pay  out 
gold  in  the  payment  of  debts  or  for  commodities  so  long 
as  it  could  be  exchanged  anywhere  in  the  world  for  a 
quantity  of  silver  that  would  do  more  money  work. 
Gold  would  absolutely  retire  from  circulation  in  this 
country  until  the  demand  for  silver  would  have  brought 
the  value  of  the  latter  metal  to  a  par  with  gold  at  a  ratio 
of  16  to  1. 

224.  The  50-cent  dollar. — The  persons  who  threat- 
ened the  country  with  the  bogey  of  the  50-cent  dollar 
forgot  the  influence  which  an  enormous  demand  would 
have  on  the  value  of  silver.     As  rapidly  as  the  gold  was 
withdrawn   from   other   countries,    in   those   countries 


BIMETALLISM  187 

prices  would  rise.  The  only  nations  which  had  large 
quanties  of  silver  were  India,  Mexico  and  China.  The 
silver  in  the  gold-standard  countries  was  to  a  large 
extent  needed  there  for  subsidiary  coinage. 

The  effect  of  withdrawing  any  considerable  quantity 
of  silver  from  silver-standard  countries  would  be  to 
reduce  the  money  supply  there,  causing  an  appreciation 
in  the  value  of  silver  as  compared  with  commodities  and 
putting  those  countries  in  a  far  worse  position  in  con- 
sequence of  the  appreciating  standard,  than  the  United 
States  had  been. 

The  silver  prices  of  commodities  in  those  countries 
would  have  fallen  so  low  that  large  exports  would  have 
been  inevitable.  After  the  confusion  incident  to  the 
alteration  of  the  standards  had  passed  and  the  new  equi- 
librium established,  it  is  doubtful  whether  the  United 
States  would  have  received  any  large  proportion  of  the 
world's  supply  of  silver.  The  United  States  would 
certainly  have  found  itself  on  the  single  silver-standard 
basis  until  the  price  of  silver  had  reached  par  with  gold 
16  to  1,  and  perhaps  for  a  considerable  time  thereafter. 
People  would  have  learned  to  appreciate  gold  to  such 
an  extent  that  it  is  not  likely  the  habit  formed  during 
this  interval  could  be  easily  broken. 

225.  Probable  results  of  free  silver. — It  is  quite 
likely  that  the  victory  of  the  free  silver  party  would 
have  resulted  in  a  very  sharp  rise  of  prices;  then  as  the 
value  of  silver  rose  toward  a  parity  with  gold,  a  de- 
cline from  the  new  high  level  would  probably  have 
begun,  so  that  the  gradually  appreciating  level  of  prices 
which  had  been  hoped  for  by  the  silver  leaders  would 
not  have  occurred.  There  would  probably  have  been 
a  gradual  rise  of  prices  in  all  gold-standard  countries 
corresponding  to  the  gradual  decline  in  silver-using 


188  MONEY  AND  BANKING 

countries.  The  greatest  beneficiaries  of  free  silver 
would  therefore  have  been  those  countries  which  had 
been  charged  with  causing  the  whole  trouble. 

So  when  two  countries  are  using  different  metals  as  money  a 
fall  in  the  value  of  one  causes  the  country  using  it  to  increase 
its  exports  by  an  amount  sufficient  to  pay  for  the  additional 
quantity  of  metal  needed  in  its  money  supply.  If  the  value  of 
one  rises,  the  exports  of  the  country  using  the  other  metal  as 
money  will  apparently  be  stimulated  but  will  not  in  the  long 
run  be  increased  in  quantity.  The  free  coinage  of  silver  could 
have  given  the  United  States  no  advantage  in  the  markets  of  the 
world  unless  silver  had  continued  to  depreciate,  in  which  case  the 
United  States  would  simply  have  increased  its  exports  by  an 
amount  sufficient  to  pay  for  the  additional  silver  which  it  needed 
as  money.  It  is  doubtful  if  such  an  increase  of  exports  could 
be  called  advantageous,  for  we  should  have  been  giving  to  the 
world  larger  and  larger  quantities  of  wheat,  cotton,  etc.,  in  ex- 
change for  a  cheapening  metal.  There  was  no  certainty,  how- 
ever, that  even  this  doubtful  advantage  would  have  been  gained, 
for  silver,  if  we  coined  it  freely,  would  have  been  quite  as  likely 
to  rise  in  value  as  to  fall.1 

If  free  coinage  of  silver  had  become  a  fact  the  debtor 
class  would  have  gained  enormously  at  the  expense  of 
the  creditors;  the  western  farmer  would  have  been  able 
to  pay  off  his  mortgages  easily.  So  far  the  silver  lead- 
ers were  probably  correct  in  their  predictions.  To  off- 
set this  advantage,  however,  the  country  would  probably 
have  experienced  a  period  of  monetary  chaos  extending 
over  a  period  of  some  years.  During  this  time  there 
would  have  been  a  great  reluctance  on  the  part  of  busi- 
ness men  to  enter  into  contracts  involving  the  future 
payment  of  money.  The  banking  business,  foreign 
exchange  and  the  whole  mechanism  of  credit  would  have 

i  Johnson,  "  Money  and  Currency,"  p.  259. 


BIMETALLISM  189 

been  thrown  out  of  adjustment,  so  that  in  spite  of  the 
stimulating  effect  of  the  higher  prices  it  is  likely 
that  general  business  would  have  diminished  in  volume 
below  the  low  level  reached  in  1896. 

The  sudden  rise  of  prices  would  have  stimulated 
speculation  to  a  most  unwarranted  degree  and  the  credit 
which  would  have  been  created  in  these  transactions 
would  have  been  of  the  most  ephemeral  and  dangerous 
character. 

226.  The  real  debtor  class. — The  advantage  which 
free  silver  would  have  brought  to  the  debtor  class  in 
general  must  not  be  exaggerated.  Popular  sympathy 
is  always  with  the  debtor,  who  is  pictured  as  a  poor  man 
at  the  mercy  of  a  wealthy  one.  The  holder  of  the  mort- 
gage against  the  struggling  western  farmer  was  al- 
ways conceived  to  be  a  corpulent  and  greedy  capitalist. 
An  accurate  conception  of  the  debtor  and  creditor 
classes  would  practically  reverse  this  popular  idea. 
The  greatest  debtors  in  the  country  are  the  banks,  who 
owe  millions  of  dollars  to  their  depositors ;  also  the  great 
corporations  which  have  enormous  bond  issues  on  which 
they  must  pay  interest.  While  the  farmer  was  strug- 
gling with  his  little  mortgage,  the  great  railroad  and 
other  corporations  of  the  country  were  having  exactly 
a  similar  experience  with  their  mortgages.  As  a  gen- 
eral rule  the  great  financiers  are  more  likely  to  be  debt- 
ors than  creditors,  for  their  very  wealth  comes  from  the 
profitable  use  of  funds  borrowed  of  other  people. 

On  the  other  hand  the  creditors  of  the  country  are  the 
great  mass  of  people  who  have  deposits  in  banks  or 
shares  in  building  and  loan  associations  or  policies  in 
life  insurance  companies.  They  are  the  great  universi- 
ties and  other  endowed  institutions  of  the  country.  In 
short  they  are  the  people  who  possess  properties  which 


190  MONEY  AND  BANKING 

they  are  not  able  to  use  in  business  themselves  and  in- 
trust to  others  to  use  for  them. 

227.  Solution  of  the  silver  question. — The  end  of  the 
free-silver  agitation  did  not  come  because  of  the  admis- 
sion that  either  side  had  been  in  error,  nor  did  it  come 
because  the  defeated  party  accepted  the  result  without 
protest.  Like  the  tariff  the  silver  question  would  prob- 
ably have  been  a  perennial  one  if  it  had  not  been  that 
the  whole  problem  was  eliminated  by  nature  herself. 
Even  when  the  agitation  was  at  its  height  the  natural 
remedy  for  the  scarcity  of  the  standard  metal  had  be- 
gun to  work.  The  tendency  to  lower  prices  for  com- 
modities had  extended  to  the  materials  and  labor  used 
in  gold  mining  with  the  result  that  the  margin  of  profit 
between  the  cost  and  the  proceeds  had  widened  until 
the  industry  became  very  attractive.  Moreover  the 
processes  for  obtaining  the  gold  from  low-grade  ores 
at  a  fraction  of  the  former  cost,  described  in  the  chapter 
on  the  production  of  gold,  were  beginning  to  have  their 
inevitable  effect  and  within  half  a  dozen  years  the 
change  was  so  abrupt  that  instead  of  apprehension  be- 
cause of  the  threatened  scarcity  of  gold,  the  authorities 
began  to  be  alarmed  lest  the  excessive  production  of 
gold  might  lead  to  disastrous  economic  consequences. 

At  the  same  time,  however,  the  production  of  silver 
was  increasing  at  an  equal  pace,  due  largely  to  the  fact 
that  it  is  an  important  by-product  of  copper  production, 
which  had  experienced  an  extraordinary  boom  follow- 
ing the  development  of  electrical  machinery.  For  this 
reason  the  increased  production  of  gold  did  not  solve  the 
monetary  problem  for  countries  on  a  silver-standard 
basis.  Without  adopting  the  gold  standard,  several  of 
these  countries  have  been  able  to  eliminate  the  difficul- 
ties inherent  in  a  standard  different  from  that  of  the 


BIMETALLISM  191 

principal  trading  countries  of  the  world.  This  happy 
result  was  reached  without  political  agitation  by  a  com- 
mission of  expert  economists  from  all  the  important 
countries  of  Europe,  and  including  Jeremiah  W.  Jenks, 
Charles  A.  Conant  and  H.  H.  Hanna,  Americans  well 
known  for  their  connection  with  the  monetary  discus- 
sions. The  system  which  they  worked  out  is  called  the 
"gold  exchange  standard"  and  has  been  applied  to  sev- 
eral countries  on  the  silver  basis. 

228.  Gold  exchange  standard  in  Mexico. — Mexico 
adopted  the  system  in  1905  and  the  standard  unit  of 
money  in  that  country  is  the  Mexican  dollar  or  peso, 
which  contains  silver  to  the  amount  of  about  50  cents 
in  gold.  Without  interfering  with  its  function  as  a 
standard  of  value  the  right  of  free  coinage  was  with- 
drawn from  silver.  By  regulating  the  amount  of  silver 
coined  and  by  the  sale  of  foreign  exchange  at  a  fixed 
rate  so  as  to  prevent  the  export  of  gold  or  the  appear- 
ance of  a  premium  on  gold  for  export  the  Government 
is  able  to  maintain  a  fixed  ratio  between  the  silver  peso 
and  gold.  The  country  is  protected  against  a  sudden 
decline  in  the  price  of  silver  because  of  the  control  exer- 
cised by  the  Government  over  the  coinage  of  silver 
pesos.  A  fall  in  the  bullion  value  of  the  peso  does  not 
lower  the  value  of  the  coin  as  money  because  the  de- 
mand for  them  for  monetary  uses  maintains  their  value 
irrespective  of  the  worth  of  the  bullion. 

The  Mexican  dollar  is  a  very  popular  medium  of  ex- 
change in  the  silver-using  countries,  and  an  extraor- 
dinary number  of  them  has  been  distributed  throughout 
the  world.  In  order  to  prevent  their  return  to  Mexico 
in  large  quantities  in  the  event  of  a  fall  in  their  bullion 
value,  which  might  cause  them  to  be  rejected  in  trade, 
the  Government  has  placed  a  customs  duty  upon  them, 


192  MONEY  AND  BANKING 

which  can  be  so  adjusted  as  to  prevent  their  influx  into 
the  country  sufficiently  to  depress  the  value  of  the  peso 
below  the  present  level. 

In  the  event  of  a  rise  of  the  price  of  silver  above  64 
cents  per  ounce,  at  which  price  the  peso  is  equivalent  to 
50  cents  in  United  States  money,  the  coins  will  be  worth 
more  as  bullion  than  they  are  money  and  will  be  ex- 
ported from  the  country  to  be  sold  in  the  silver  market. 
The  resultant  contraction  of  the  currency  will  raise  the 
value  of  the  peso  as  a  coin  to  a  par  with  its  value  as 
bullion.  To  provide  for  this  contingency  there  is  a 
condition  in  the  system  for  the  free  coinage  of  gold 
pesos  which  would  supply  Mexico  with  gold  coins  in  the 
place  of  the  disappearing  silver  pesos.  The  subsidiary 
coins  would  still  remain  in  circulation,  however,  being 
underweight  as  compared  with  the  standard  coin.  A 
rise  of  the  price  of  silver,  therefore,  would  place  Mex- 
ico at  once  upon  a  gold  standard  basis. 

Under  the  present  plan  with  the  price  of  silver  below 
50  cents  per  peso  Mexico  has  a  basis  of  silver  credit 
money  redeemable  in  gold,  because  the  Government 
guarantees  to  sell  foreign  exchange  calling  for  gold  in 
England  and  other  countries  in  exchange  for  the  money 
of  the  country.  This  amounts  intrinsically  to  redemp- 
tion in  gold. 


PART  II:    BANKING 

CHAPTER  XII 

NATURE  OF  CREDIT 

229.  Origin  and  kinds  of  credits. — A  credit  is  a  de- 
ferred or  postponed  payment  of  money.  It  always 
represents  a  promise,  express  or  implied,  to  pay  a  certain 
number  of  dollars  at  some  time,  definite  or  indefinite. 
Inasmuch  as  it  is  a  promise  to  pay  money,  certain 
forms  of  it  circulate  in  lieu  of  money,  the  ease  and 
extent  of  this  circulation  depending  directly  upon  the 
integrity  and  ability  to  pay  of  the  maker  of  the  credit, 
and  the  date  and  conditions  of  payment. 

Credits  come  into  existence  always  as  the  result  of  an 
exchange,  either  the  exchange  of  credit  for  goods, 
credit  for  money,  or  credit  for  credit.  If  A  purchases 
goods  from  B,  he  may  tender  in  payment  either  gold, 
his  personal  check,  bank  notes,  United  States  notes  or 
his  own  promise  to  pay  in  sixty  days.  If  the  payment 
is  made  in  gold,  no  credit  operation  is  involved.  If 
made  by  check  or  in  bank  notes,  it  represents  merely  a 
transfer  of  credit  already  created  by  the  bank.  If 
made  in  United  States  notes  it  is  likewise  a  transfer  of 
credit,  this  time  of  Government  credit.  If  payment  is 
made  by  his  own  promissory  note,  however,  a  new  credit, 
payable  at  a  definite  time,  is  created. 

Credit  is  of  two  kinds — non-circulating  and  circulat- 
ing. Non-circulating  credit  accomplishes  one  ex- 
change while  circulating  credit  accomplishes  many.  In 
vn-13 


194  MONEY  AND  BANKING 

the  case  above  if  A  pays  with  a  promissory  note,  an 
exchange  has  been  made  by  means  of  the  credit  thus 
created.  At  the  end  of  sixty  days,  however,  the  credit 
must  be  liquidated,  by  means  of  cash,  if  it  has  not  been 
cancelled  by  an  exchange  of  property  in  the  opposite 
direction.  The  credit  which  served  as  a  medium  of  ex- 
change in  the  first  transaction  must  itself  be  exchanged 
for  cash  at  maturity,  and  the  whole  transaction  amounts 
in  the  end  to  an  exchange  of  goods  for  cash  extending 
over  a  period  of  sixty  days. 

230.  Use  of  credit  in  industry. — Under  our  capital- 
istic system  of  industry  every  enterprise  requires  cap- 
ital. The  entrepreneur  must  have  buildings,  land,  ma- 
chinery— a  great  variety  of  capital  goods  which  make 
up  the  plant  and  equipment  of  the  business — and  he 
must  have  the  services  of  employes  and  raw  materials. 
He  must  prepare  for  the  various  expenses  of  the  busi- 
ness— wages,  taxes,  etc.  If  he  is  not  a  capitalist  him- 
self and  cannot  induce  capitalists  to  share  with  him  the 
risks  and  profits  of  his  business,  he  must  borrow  this 
property  from  others.  All  these  obligations  are  credits 
and  must  sometime  be  liquidated  by  the  payment  of 
cash. 

The  form  which  these  credits  will  take  will  be  deter- 
mined largely  by  the  nature  of  the  business,  the  sagacity 
of  the  entrepreneur  himself  and  the  condition  of  the 
credit  market.  We  have  seen  that  credits  vary  in  re- 
spect to  time  and  conditions  of  payment.  Most  entre- 
preneurs are  capitalists  to  a  certain  extent,  their  demand 
for  credit  arising  from  the  fact  that  they  expect  to 
enlarge  their  business  by  supplementing  their  capital. 
Let  us  suppose  that  a  manufacturer  owns  outright  his 
lands,  factory  and  machinery,  and  in  addition  has  a 
working  capital  sufficient  to  meet  his  payrolls  and  ex- 


NATURE  OF  CREDIT  195 

penses  for  some  time  to  come.  He  has  also  a  stock  of 
finished  product  on  hand,  the  market  for  which  is  sea- 
sonal and  which  amounts  to  only  one-half  the  product 
which  he  expects  to  market,  or  perhaps  has  contracted 
to  deliver  when  the  season  comes.  Obviously  he  must 
have  more  raw  material,  and  if  he  cannot  purchase  it  on 
credit,  he  will  go  to  his  banker,  make  a  complete  state- 
ment of  his  condition,  and  if  it  is  satisfactory,  give  to 
the  bank  his  promissory  note  maturing  at  a  date  when 
he  will  have  marketed  his  product.  In  return  for  this 
he  will  receive  a  credit  on  the  bank's  books,  which  will 
enable  him  to  purchase  the  desired  material. 

231.  Function  of  commercial  banking. — This  is  the 
great  function  of  commercial  banking,  to  enable  manu- 
facturers and  merchants  to  enlarge  their  business  by 
extending  to  them  for  short  periods  the  use  of  credit 
by  which  they  can  carry  goods  from  the  time  of  pur- 
chase to  that  of  sale.  The  readiness  with  which  credit 
will  be  granted  depends  upon  the  reputation  of  the 
manufacturer  or  merchant  for  selling  his  product,  the 
amount  of  credit  asked  for  and  upon  the  nature  of  the 
business.  In  dull  times  not  every  commodity  will  sell, 
yet  upon  the  proceeds  of  the  sale  depends  the  redemp- 
tion of  the  credit.  Therefore  those  who  deal  in  articles 
which  are  always  reasonably  sure  to  sell,  such  as  food 
products,  clothing  and  in  general  the  necessities  of  life, 
are  the  most  certain  to  obtain  credit  and  in  the  largest 
amounts  relative  to  their  capital  investment.  Reputa- 
tion for  selling,  however,  is  a  great  factor,  and  credit 
is  often  extended  on  this  account  even  to  those  whose 
product  is,  generally  speaking,  not  apt  to  be  quickly 
convertible. 

It  may  be,  however,  that  the  entrepreneur  after  reach- 
ing the  limit  of  his  own  resources,  will  prefer  to  add 


196  MONEY  AND  BANKING 

permanently  to  his  working  capital  instead  of  increasing 
and  decreasing  it  as  his  business  demands.  It  may  be 
that  the  nature  of  his  business  is  such  that  he  finds  it 
difficult  to  obtain  credit  in  dull  times.  Even  in  pros- 
perous times  he  may  feel  that  a  general  contraction  of 
credits  is  due,  and  that  he  may  be  unable  to  market  his 
product  to  meet  his  obligations.  If  such  is  the  case,  he 
may  add  to  his  working  capital  by  borrowing  for  a  long 
period,  placing  a  mortgage  upon  his  real  property. 

232.  Mortgages  and  bonds. — A  mortgage  is  a  secured 
credit,  that  is,  secured  by  the  pledge  of  specific  prop- 
erty.    The  most  common  form  in  which  this  kind  of 
credit  is  used,  is  that  of  bonds.     A  bond  is  a  portion  or 
fraction  of  a  mortgage.     When  mortgages  are  so  large 
in  amount  that  in  their  entirety  they  cannot  find  a  mar- 
ket with  any  one  individual  or  institution,  they  are 
divided  into  parts,  called  bonds,  for  distribution.     This 
credit  must  be  redeemed,  of  course,  at  its  maturity  just 
like  the  short-time  credit,  but  the  maturity  is  usually  far 
enough  distant  to  give  the  entrepreneur  an  opportunity 
of  meeting  it  out  of  his  accumulated  profits.     Moreover 
if  the  property  which  secures  it  has  not  depreciated  in 
the  meantime,  it  can  often  be  renewed  at  maturity. 

This  form  of  credit  is  ordinarily  used  when  the  pro- 
ceeds of  the  loan  are  to  be  used  for  some  fixed  or  per- 
manent investment.  Thus  it  is  the  form  commonly  used 
by  railroads,  public  service  corporations,  large  industrial 
corporations  owning  valuable  real  property,  and  the 
like.  The  interest  on  the  bonds  is  paid  out  of  the  sav- 
ings of  the  corporation,  and  when  they  mature  the 
principal  is  paid  by  the  sale  of  new  securities. 

233.  Example  of  timber  industry. — There  are  cer- 
tain industries,  however,  in  which  both  these  methods  of 
obtaining  credit  are  used.     A  good  example  is  the  lum- 


NATURE  OF  CREDIT  197 

ber  industry.  We  have  seen  that  the  merchant  and 
manufacturer  of  quickly  convertible  products  will  ordi- 
narily borrow  commercially  and  that  railroads  and  sim- 
ilar corporations  will  borrow  on  long-time  obligations 
because  the  money  so  obtained  is  to  be  used  in  permanent 
investment,  and  the  obligations  cannot  be  redeemed  ex- 
cept by  refunding.  The  lumberman  is  of  course  a 
manufacturer  but  his  product  is  not  always  quickly  con- 
vertible. When  a  panic  comes,  people  must  still  have 
food  and  clothing  but  they  can  get  along  without  build- 
ing new  houses.  Therefore  lumber  is  one  of  the  first 
commodities  to  feel  the  depression  through  a  falling 
off  in  demand. 

A  complete  lumbering  industry  will  own  a  saw  mill, 
a  supply  of  timber  sufficient  to  last  for  a  number  of 
years,  and  a  quantity  of  manufactured  lumber  piled  in 
the  yards  awaiting  sale.  In  this  country  lumbermen 
have  always  been  large  borrowers.  The  price  of  lum- 
ber, and  the  value  of  timber  land  have  advanced  steadily 
with  the  decrease  of  the  available  supply.  Lumbermen 
have  been  quick  to  take  advantage  of  this  condition,  and 
have  always  been  eager  to  borrow  to  add  to  their  timber 
holdings.  When  the  northern  lumbermen  began  to  go 
south  in  the  eighties  they  found  that  timber  land  was 
cheap  and  that  it  could  be  bought  on  credit,  hence  they 
invested  their  capital  in  equities.  That  is,  they  made  a 
first  payment  in  cash,  agreeing  to  pay  an  additional 
amount  every  year  or  as  the  timber  was  cut.  Obvi- 
ously they  must  manufacture  and  market  lumber  in 
order  to  meet  their  obligations.  As  soon  as  the  product 
was  ready  for  sale  it  was  a  "bankable  asset"  because  in 
boom  times  lumber  finds  a  ready  market.  Conse- 
quently lumbermen  became  large  commercial  borrow- 
ers, the  amount  of  their  short-time  credit  outstanding 


198  MONEY  AND  BANKING 

often  exceeding  the  value  of  the  manufactured  stock 
on  hand. 

234.  Advantages  of  timber  bonds. — Since  the  year 
1900,  however,  many  dealers  in  lumber  have  taken  ad- 
vantage of  the  increase  in  value  of  their  timber  lands  to 
retire  their  outstanding  notes  and  the  obligations  they 
incurred  in  the  original  purchase  of  this  land,  by  issuing 
bonds  secured  by  all  their  real  property.     These  bonds 
are  usually  serial,  a  certain  amount  of  them  maturing 
every  year  as  the  timber  is  cut.     The  advantage  of  this 
method  of  borrowing  is  obvious.     Only  a  fraction  of 
their  indebtedness  must  be  met  each  year,  and  they  know 
beforehand  just  what  that  amount  will  be  and  can  pre- 
pare for  it.     When  they  borrow  on  short-time  notes 
and  a  panic  occurs,  they  may  find  it  very  difficult  either 
to  sell  their  product  or  to  renew  their  notes.     Almost 
their  entire  indebtedness  is  likely  to  become  due  within 
six  months,  and  if  conditions  do  not  improve,  there  is 
grave  danger  of  bankruptcy.     It  is  probable  that  this 
condition  was  largely  responsible  for  the  big  slump  in 
the  price  of  Southern  pine  following  the  panic  of  1907. 
There  was  such  a  great  amount  of  short  time  lumber 
credits  outstanding,  that  the  competition  between  sellers 
became  acute  and  prices  declined  very  sharply.     The 
lumbermen  whose  obligations  were  in  the  form  of  bonds, 
however,  did  not  enter  this  competition,  so  did  not  sacri- 
fice either  their  manufactured  product  or  their  timber. 

235.  Interest  rates  on  bonds. — The  form  which  this 
borrowing  will  take,  however,  is  further  influenced  by 
the  condition  of  the  credit  market,  as  evidenced  by  the 
prevailing  rate  of  interest.     The  rate  of  interest  paid 
upon  the  various  kinds  of  long-time  obligations  is  fairly 
well  fixed,  although  it  varies  somewhat  with  the  demand 
or  supply  of  such  investments.     Thus  railroad  bonds 


NATURE  OF  CREDIT  199 

bear  from  3%  per  cent  to  4%  per  cent  interest;  public 
service  corporation  bonds  from  4^  per  cent  to  5%  per 
cent  and  industrial  and  real  estate  mortgage  bonds  from 
5  per  cent  to  6  per  cent.  These  rates  are  fixed  by  the 
regard  in  which  the  bonds  are  held  by  investors  in  re- 
spect to  security  of  principal  and  convertibility  into  cash. 
The  rate  at  which  the  commercial  borrower  must  dis- 
count his  note,  however,  varies  within  much  greater 
limits.  It  may  be  as  low  as  3  per  cent  when  the  demand 
for  credit  is  small  and  the  banks  are  eager  to  loan. 
This  condition  is  known  as  "easy  money."  When  busi- 
ness improves  and  demand  for  credit  increases,  the  rate 
advances  until  in  time  of  panic  it  may  be  as  high  as  10 
or  12  per  cent.  The  average  is  from  4  to  5  per  cent. 

236.  Long-time    borrowing. — Naturally   the    entre- 
preneur wishes  to  borrow  money  at  the  lowest  possible 
rate.     During  periods  of  easy  money  he  is  loath  to  re- 
tire his  short-time  indebtedness  on  which  he  may  be 
paying  4  per  cent  by  the  issue  of  bonds  which  will  cost 
him  6  per  cent.     As  money  becomes  tight,  however,  he 
becomes  anxious  to  make  this  change,  but  often  the  time 
has  passed  when  the  market  will  absorb  his  bonds. 
Thus,  in  an  endeavor  to  obtain  the  lowest  rate  at  all 
times,  there  is  danger  of  his  rinding  himself  in  a  tight 
money  market  with  all  his  obligations  in  short-time 
form.     The  advantage   of  long-time  borrowing  in  cer- 
tain lines  of  industry  is  so  obvious,  however,  that  sagaci- 
ous business  men  will  often  sell  high-rate  bonds  when 
the  commercial  rate  is  much  lower,  knowing  that  in  the 
long  run  their  interest  account  will  average  lower,  and 
that  in  case  of  panic  their  situation  will  be  much  more 
secure. 

237.  Credit  economizes  the  use  of  gold. — Credit  is 
like  fire — a  good  servant,  but  a  bad  master.     So  long 


200  MONEY  AND  BANKING 

as  it  is  controlled  and  prevented  from  sudden  contract- 
tion  it  serves  to  economize  the  use  of  gold,  doing  the 
work  of  exchanging  goods  more  conveniently  than  gold 
itself.  We  have  seen  that  prices  depend  upon  the 
amount  of  the  media  of  exchange.  The  use  of  credit, 
therefore,  permits  business  to  expand  and  trading  to  be 
accelerated  without  a  reduction  of  prices,  but  on  the 
other  hand  its  use  destroys  the  check  which  otherwise 
would  prevent  prices  from  rising  to  an  artificial  height 
thus  bringing  on  a  panic.  A  discussion  of  the  effect 
of  credit  on  prices,  however,  belongs  to  a  later  chapter. 

238.  Liquidation  of  credit. — We  have  seen  that  all 
private  credits  must  in  the  end  be  liquidated  by  means 
of  cash.  During  a  time  of  prosperity  when  prices  are 
rising  and  fortunes  are  being  made  simply  by  buying 
at  a  low  price  and  selling  at  a  higher,  many  people  pur- 
chase property  on  credit,  usually  giving  the  property 
as  security  for  the  credit.  The  profits  of  industry  are 
increasing,  hence  business  men  are  straining  every 
nerve  to  increase  their  business.  To  do  this  they  must 
obtain  credit.  Furthermore  at  such  times  bankers  be- 
come accustomed  to  seeing  goods  sold  and  credits 
liquidated,  and  they  loan  more  freely.  Their  portfolios 
are  full  of  time  credits,  maturing  in  the  future,  acquired 
in  exchange  for  demand  credits  due  whenever  called 
for. 

At  such  a  time  suppose  a  political  or  financial  dis- 
turbance shakes  public  confidence  in  the  ability  of 
debtors — especially  banks — to  meet  their  obligations;  a 
demand  for  the  pament  of  such  credits  as  are  due  is  sure 
to  follow.  Since  the  obligations  of  a  bank  are  always 
due  and  payable,  they  are  apt  to  suffer  a  "run."  When 
this  occurs  they  must  themselves  request  payment  of  all 
credits  that  are  due  them  and  make  practically  no  re- 


NATURE  OF  CREDIT  201 

newals.  Other  banks  follow  suit.  This  forces  the 
merchant  and  manufacturer  as  their  notes  become  due  to 
sell  their  goods  at  a  sacrifice,  and  before  we  know  it  we 
are  in  the  midst  of  a  financial  panic. 

239.  Commercial  paper  houses  and  the  credit  situa- 
tion.— The  danger  of  this  condition  has  been  somewhat 
augmented  by  the  custom  of  large  borrowers  discount- 
ing their  notes  through  commercial  paper  houses. 
While  this  is  more  necessary  on  account  of  the  process 
of  consolidation  which  has  gone  on  in  industry  in  the 
last  decade,  it  nevertheless  injects  into  the  situation  a 
further  element  of  danger.  Formerly  the  merchant 
borrowed  from  his  own  bank  direct,  or  if  his  business 
was  large,  from  two  or  three  banks  in  his  own  city. 
He  knew  the  bankers  personally,  and  kept  an  account 
at  each  bank.  They  were  anxious  to  serve  him,  and 
would  do  so  if  possible,  even  in  case  of  a  panic.  Hence 
his  chances  of  renewing  his  maturing  notes  at  such 
times  were  good. 

With  consolidation,  however,  and  the  growth  of  large 
industries  came  the  necessity  of  increased  credit. 
Many  industries  are  now  so  large  that  the  banks  of  one 
city  cannot  possibly  finance  their  borrowing.  Hence 
the  necessity  of  a  notebroker  or  commercial  paper 
house,  whose  function  is  to  distribute  the  notes  of 
various  concerns  throughout  the  banks  of  the  entire 
country.  No  doubt  it  is  a  necessary  developement  of 
the  era  of  consolidation  but  it  destroys  the  personal 
element  of  banking.  The  banker  in  Kansas  has  no  per- 
sonal interest  in  the  success  or  failure  of  the  New  York 
merchant  whose  note  he  holds,  beyond  the  payment  of 
that  particular  note,  and  in  times  of  panic  he  is  quick 
to  request  valuable  payment.  The  ability  to  borrow  at 
a  large  number  of  banks  is  an  asset  during  prosperous 


202  MONEY  AND  BANKING 

times;  but  if  over-exercised,  it  can  become  almost  in  a 
moment  a  most  importunate  liability. 

240.  Use  of  credit  as  a  medium  of  exchange. — The 
most  important  function  of  credit  is  its  power  to  circu- 
late as  a  medium  of  exchange.     Obviously,  if  exchange 
can  be  consummated  in  large  volume  by  means  of  credit, 
the  necessity  of  huge  national  investment  in  the  precious 
metal  is  obviated.     The  whole  system  rests  upon  the 
assumption  that  not  everyone  is  going  to  present  de- 
mand credits  for  redemption  at  the  same  time.     Ex- 
cept in  extreme  instances,  the  assumption  is  a  good  one, 
and  credit  has  become  the  chief  medium  of  exchange  of 
this  country. 

In  order  to  circulate  in  lieu  of  money,  credit  must 
be  payable  on  demand.  Furthermore,  the  issuer  must 
be  one  in  whose  integrity  and  ability  to  pay,  the  public 
has  entire  confidence.  Naturally,  then,  the  credit 
which  circulates  the  most  freely  is  Government  credit. 
Second  to  this  is  bank  credit,  and  as  this  is  the  medium 
in  which  a  large  proportion  of  our  exchange  is  made,  it 
is  well  to  consider  it  separately. 

241.  Bank  credit. — Bank  credit  has  two  forms,  notes 
and  deposits.     The  true  bank  note  is  the  simple  promise 
of  the  bank  to  pay  legal  tender  on  demand;  the  de- 
posit is  precisely  the   same  except   in   form.     These 
credits  are  created  as  the  result  of  an  exchange,  either 
of  money  for  credit,  or  credit  for  credit.     If  the  cus- 
tomer brings  money  to  the  bank  he  receives  for  it  either 
notes  or  a  deposit  account,  depending  upon  which  will 
best  suit  his  needs.     If  he  comes  to  the  bank  as  a  bor- 
rower, he  exchanges  his  own  time  credit  for  the  bank's 
demand  credit  and  again  takes  it  in  either  form  he  de- 
sires.   It  is  the  credits  thus  created  which  perform  so 


NATURE  OP  CREDIT  203 

great  a  proportion  of  our  money  work.  The  notes 
themselves  passing  from  hand  to  hand,  and  the  checks 
drawn  against  the  deposits  consummate  probably  90 
per  cent  of  our  exchanges. 

The  issue  of  credits  intended  for  circulation  by  pri- 
vate persons,  corporations  and  banks  has  been  attended 
by  so  much  abuse  in  the  past  that  governments  have 
come  to  regard  it  as  a  quasi-public  function  which  must 
be  regulated  strictly.  Accordingly  in  this  country  the 
banks  have  lost  the  power  to  issue  true  bank  notes,  and 
can  only  issue  notes  secured  by  a  deposit  of  government 
bonds  with  the  United  States  Treasury.  Our  bank 
notes  therefore  are  really  Government  bonds  converted 
into  currency.  Each  note  is  simply  a  fragment  of  a 
bond  stripped  of  its  interest  and  payable  on  demand. 

242.  Deposit  credit. — The  other  form  of  circulating 
credit,  or  credit  currency,  consists  of  checks  and  drafts 
drawn  against  deposit  credits.  The  currency  is  not  the 
check  or  draft  but  the  deposit  credit  itself;  the  docu- 
ment is  simply  a  temporary  form  which  the  deposit 
takes  for  circulation.  The  drawing  and  paying  of 
checks  do  not  expand  or  contract  the  deposit  currency 
but  merely  measure  its  rate  of  circulation. 

This  form  of  credit  has  been  found  to  be  much  better 
suited  to  the  needs  of  thickly  settled  communities  than 
the  bank  note  currency,  whereas  in  new  regions  with 
poor  banking  facilities,  notes  are  still  the  favorite 
medium.  This  is  because  of  the  fact  that  in  new 
regions,  transactions  are  smaller;  whereas  in  the  cities 
transactions  are  large  and  it  would  be  most  burden- 
some to  carry  about  large  amounts  of  bank  notes  with 
which  to  settle  obligations.  It  is  only  in  this  country, 
however,  that  the  deposit  currency  has  reached  its  full- 


204  MONEY  AND  BANKING 

est  development  and  it  is  noteworthy  that  even  here  it 
did  not  begin  to  do  so  until  restrictions  were  placed  by 
the  Government  upon  the  issue  of  bank  notes. 

Up  to  1855  the  note  issues  of  the  banks  exceeded 
their  deposits.  In  that  year  deposits  forged  ahead 
somewhat,  but  it  was  not  until  the  national  bank  act  of 
1865  that  they  were  given  thier  real  impetus.  Since 
that  time  the  deposits  have  increased  out  of  all  pro- 
portion to  the  increase  of  the  capital  invested  in  bank- 
ing, while  the  notes  have  materially  fallen  off  in 
amount. 

243.  Elasticity  of  deposit  credit. — The  reason  for 
this  condition  is  to  be  found,  of  course,  in  the  increase 
of  population  and  the  consequent  growth  of  the  bank- 
ing habit;  but  even  more  important  than  these  factors 
in  its  growth  has  been  its  innate  ability  to  provide  a 
medium  of  exchange  which  expands  and  contracts  with 
the  business  needs  of  the  country.  There  are  certain 
times  of  the  year  when  exchanges  increase  greatly  in 
volume;  this  condition  being  particularly  true  of  single 
communities  where  industries  are  not  greatly  varied. 

Moreover,  as  business  becomes  brisk  or  slack,  there 
are  changes  in  the  volume  from  year  to  year.  This 
necessitates  a  constant  change  in  the  amount  of  the 
medium  of  exchange.  Unless  it  is  a  period  of  general 
speculation  and  credits  rest  upon  an  unstable  basis,  this 
change  in  the  demand  for  medium  will  be  met  auto- 
matically by  an  increase  or  decrease  of  checks  and 
drafts  drawn  against  the  deposit  currency.  We  shall 
see  later  on  that  this  is  the  only  currency  in  use  in  this 
country  that  had  this  attribute  of  elasticity.  It  is  ob- 
vious that  the  issue  of  bank  notes  which  must  be  first 
secured  by  deposit  of  Government  bonds  with  the 
Treasury  is  exceedingly  inelastic. 


NATURE  OF  CREDIT  205 

Having  come  into  existence  as  the  result  of  an  ex- 
change transaction,  these  circulating  credits  serve  as  a 
medium  of  exchange  in  a  number  of  transactions  before 
they  are  extinguished.  They  are  usually  liquidated  by 
cancellation  of  one  against  the  other  rather  than  by  pay- 
ment of  money;  so  that  the  exchanges  which  they  have 
made  have  not  merely  postponed  the  actual  transfer  of 
money  as  in  the  case  of  the  non-circulating  credits. 
The  fact  that  they  serve  the  purpose  of  money  and  are 
usually  settled  by  cancellation  misleads  people  into 
supposing  that  they  obviate  the  need  for  money.  That 
such  is  not  the  case  they  learn  sometimes  to  their  sor- 
row when  there  comes  a  general  demand  for  the  redemp- 
tion of  credits  according  to  their  tenor. 

The  volume  of  credits  contracts  whenever  there  is 
liquidation  or  whenever  they  become  depreciated  in 
value.  As  long  as  the  debtor  continues  to  meet  the 
matured  obligation  in  money  their  value  is  maintained 
but  whenever  he  refuses  to  do  this  value  begins  to  de- 
cline concurrently  with  the  chances  of  future  payment. 
A  credit  depreciated  to  half  its  par  value  has  lost  half 
its  power  to  do  money  work  and  is  contracted  half  as 
much  as  if  it  had  been  liquidated. 

Inasmuch  as  credit  can  serve  the  purposes  of  money 
even  better  than  money  itself,  nobody  would  ever  de- 
mand money  unless  they  thought  it  was  more  valuable 
than  the  credit,  that  is,  unless,  in  their  opinion  the  value 
of  the  credit  had  depreciated.  Such  a  depreciation 
could  take  place  only  when  confidence  in  the  ability  of 
the  debtor  to  pay  was  impaired.  The  only  exception 
to  this  are  cases  where  gold  is  required  for  use  in  the 
arts  and  for  foreign  payments.  The  run  on  the  Gov- 
ernment in  1893-4  for  gold  for  the  redemption  of 
greenbacks  was  caused  by  the  demand  for  gold  to  be 


206  MONEY  AND  BANKING 

exported  in  settlement  of  the  international  balance 
which  had  gone  against  us.  This  legitimate  and 
regular  demand  for  gold  soon  led  to  another  demand 
which  arose  because  people  began  to  fear  that  the  Gov- 
ernment might  not  be  able  to  meet  its  obligations. 

To  maintain  the  value  of  outstanding  credits  it  is 
necessary  for  the  issuer  to  sustain  the  confidence  of  the 
public  in  his  ability  to  pay  on  demand.  This  can  be 
done  only  by  keeping  within  easy  reach,  money  enough 
to  satisfy  all  but  the  most  extraordinary  demands.  It 
is  not  enough  that  he  have  property  which  is  ordinarily 
convertible  into  means  of  payment,  for  when  the  de- 
mand for  liquidation  comes  it  is  likely  to  fall  on  every- 
one at  once  and  no  one  will  care  to  part  with  money. 
Safely  for  the  issuer  of  demand  credits,  therefore,  lies 
only  in  keeping  at  all  times  a  reserve  of  money  suffi- 
cient to  maintain  confidence  in  his  ability  to  pay.  This 
reserve  is  the  basis  of  outstanding  credits. 

244.  Gold  the  basis  for  all  credit. — The  basis  for 
bank  credit  is  reserve  money.  All  of  this  reserve 
money  except  gold  coin  is  based  more  or  less  on  the 
credit  of  the  government.  It  is  kept  at  par  with  gold 
because  the  government  stands  ready  to  redeem  it  dol- 
lar for  dollar  upon  demand.  In  order  to  meet  possible 
demands  for  redemption  the  government  is  required  to 
keep  a  gold  reserve  of  $150,000,000.  The  principle 
behind  this  law  is  the  same  as  that  behind  the  reserve 
section  of  the  National  Bank  Act.  The  credit  money 
of  the  government  is  based  upon  gold.  The  bank 
credit  of  the  country  is  based  upon  government  credit 
money,  plus  gold.  The  ordinary  time  and  mercantile 
credit  of  the  nation  is  based  upon  bank  credit,  govern- 
ment credit,  money  and  gold.  The  following  diagram 
illustrates  the  idea: 


NATURE  OF  CREDIT 


207 


Mercantile  and  Time  Credit. 


Government  Credit  Money. 


Gold. 


245.  Reserve. — The  essential  feature  of  the  bank  is 
its  power  to  keep  outstanding  a  mass  of  non-interest 
bearing  demand  credits,  either  in  the  form  of  notes  or 
deposits,  which  it  has  issued  in  exchange  for  interest 
bearing  time  credits.     To  keep  these  demand  credits 
out,  the  bank  must  have  the  confidence  of  the  public. 
This  it  acquires  by  its  capital  and  reserve.     The  re- 
serve represents  to  the  depositor  his  protection,  should 
he  choose  to  request  immediate  redemption  of  his  credit ; 
the  capital  and  surplus,  represents  his  ultimate  pro- 
tection. 

The  national  bank  act  requires  that  national  banks 
in  central  reserve  cities  (New  York,  Chicago  and  St. 
Louis)  shall  keep  a  cash  reserve  of  25  percent  of  their 
outstanding  demand  credits.  This  reserve  consists  of 
gold,  and  Government  credit.  The  general  reserve 
cities,  of  which  there  are  forty-nine,  must  keep  25  per 
cent  reserve  with  the  privilege  of  depositing  half  of  it 
in  central  reserve  cities.  All  other  national  banks  must 
keep  a  15  per  cent  reserve  with  the  privilege  of  deposit- 
ing 3-5  of  it  in  reserve  city  banks. 

246.  Effect  of  reserve  requirements. — The  amount 
of  reserve  which  should  be  kept  by  a  bank  depends  upon 
the  nature  of  its  outstanding  demand  credits.     If  they 
are  due  to  other  banks  they  are  more  likely  to  be  called 
for  than  if  they  are  in  the  hands  of  large  numbers  of 


208  MONEY  AND  BANKING 

people  scattered  over  the  country.  The  amount  of  re- 
serve  necessary  cannot  be  determined  by  any  fixed  rule. 
The  purpose  of  the  reserve  requirements  of  the  national 
bank  act  is  to  put  a  check  on  undue  expansion  of  de- 
mand credit  by  the  banks,  and  forbids  them  making 
further  loans  as  long  as  their  reserve  is  below  the  legal 
requirements.  In  prosperous  times  this  operates  very 
well,  but  times  of  crisis  and  stringency;  are  prolonged 
by  it. 

At  such  times  each  bank  strives  to  hold  as  large  a 
reserve  as  possible,  refusing  to  make  new  loans  or  to 
renew  old  ones,  and  withdrawing  its  deposits  from  the 
city  banks.  The  effect  of  this  is  to  intensify  the 
stringency.  The  proper  policy  would  be  to  loan  freely 
so  that  solvent  firms  may  not  be  compelled  to  suspend 
because  they  cannot  get  ready  funds  with  which  to  meet 
their  current  obligations.  The  Bank  of  England  pur- 
sues this  policy  and  permits  its  reserves  to  fall  to  a  very 
low  point,  but  it  selects  automatically  the  most  urgent 
cases  for  relief  by  raising  the  rate  of  discount.  In  the 
recent  panic,  the  Secretary  of  the  Treasury  and  J.  P. 
Morgan  followed  the  correct  banking  principle  when 
they  put  on  the  market  large  sums  of  money  to  be 
loaned. 

247.  Danger  of  use  of  credit  in  panics. — It  is  during 
panics  that  an  elastic  medium  of  exchange  is  most 
needed,  and  unfortunately  the  deposit  currency,  ordin- 
arily elastic,  not  only  refuses  to  stretch  at  such  times, 
but  contracts  instead.  Just  as  soon  as  there  is  a  gen- 
eral demand  for  redemption  of  private  credits  even  the 
banks  are  compelled  to  redeem  their  credits  in  legal 
tender,  whether  their  ability  to  pay  is  thought  to  be 
impaired  or  not.  To  do  this  they  must  pay  out  their 
reserve  money.  This  in  turn  cripples  their  ability  to 


NATURE  OF  CREDIT  209 

loan  and  further  depletes  the  deposit  currency. 
Most  of  the  so-called  currency  bills  which  have  been  in- 
troduced in  Congress  have  attempted  to  remedy  the 
evil  by  authorizing  banks  to  issue  note  credits  in  pay- 
ment of  the  deposit  credits.  In  this  way  note  credits 
could  be  used  instead  of  reserve  money  for  circulation, 
and  unless  the  credit  of  the  bank  has  suffered,  reserve 
money  will  not  be  drawn  out.  Under  our  present  law 
the  issue  of  notes  is  impracticable  at  such  times  be- 
cause it  necessitates  the  purchase  of  United  States 
bonds,  which  would  further  deplete  the  amount  of  the 
reserve. 

In  spite  of  these  grave  dangers  which  attend  the  use 
of  credit  as  a  medium  of  exchange,  its  use  is  a  necessity 
of  the  era  of  modern  industry;  and  as  the  public  is 
gradually  aroused  to  a  study  of  the  problems,  its  de- 
fects will  disappear  in  the  wake  of  competent  legis- 
lation. 

248.  Importance  of  credit. — Credit  is  the  life  blood 
of  the  economic  system,  its  amount  and  condition  de- 
termining whether  business  be  healthy  and  vigorous,  or 
unhealthy  and  stagnant.  It  determines  whether  the 
population  shall  be  busy  and  prosperous  or  unemployed 
and  poverty  stricken.  Insomuch  then  as  the  science  of 
banking  and  money  is  so  intimately  concerned  with  the 
very  fundamentals  of  life, — the  procurement  of  food, 
shelter  and  clothing,  with  health  and  with  the  whole 
standard  of  living,  it  assumes  an  importance  equal  to 
any  other.  If  all  the  distress  which  followed  the  panic 
of  1907 — the  failure  of  business  men,  the  reduction  of 
incomes  among  all  classes,  the  loss  of  employment  and 
wages  by  thousands  of  workmen,  bringing  poverty  into 
innumerable  homes — if  all  this  tremendous  calamity 
was  unnecessary  and  remediable,  then  the  subject  is  one 

VII— U 


210  MONEY  AND  BANKING 

of  the  greatest  human  interest,  well  worthy  of  the  at- 
tention of  trained  investigators  and  master  minds. 

We  have  progressed  far  enough  in  our  study  to 
realize  that  the  sole  cause  of  some  of  our  panics  is  the 
misuse  of  the  credit  medium  and  that  it  is  a  leading 
factor  in  all  of  them.  Abnormal  and  sudden  contrac- 
tions and  expansions  of  credit  disturb  the  economic 
equilibrium  by  causing  fluctuations  of  prices,  manipu- 
lating profits,  and  destroying  the  spirit  of  enterprise 
among  those  who  control  the  industrial  activity  of  the 
nation. 


CHAPTER  XIII 

EFFECT  OF  CREDIT  ON  PRICES 

249.  Increasing  need  of  more  efficient  money. — We 
have  already  seen  that  the  use  of  credit  affects  the  gen- 
eral level  of  prices  by  increasing  the  efficiency  of  money. 
Were  it  not  for  credit  the  price  level  must  always  be 
fixed  by  the  rates  between  the  amount  of  goods  to  be 
exchanged  and  the  amount  of  money  in  circulation,  pro- 
vided of  course  that  the  rate  of  circulation  remain  con- 
stant.   As    population    increases,    more     goods    are 
produced  and  more  exchanging  must  be  done,  hence 
prices  are  certain  to  decline  unless  the  value  of  money  is 
increased  or  rendered  more  efficient.     Declining  prices 
lessen  profits,  the  incentive  to  enterprise  is  deadened,  the 
factors  of  production  become  idle  and  depression  is 
chronic.     A    developing    country,    therefore,     to   be 
healthy  economically  must  have  a  constantly  increasing 
quantity  of  medium  of  exchange. 

This  need  has  been  met  by  credit,  chiefly  in  the  form 
of  bank  credit.  In  the  preceding  chapters  the  several 
kinds  of  credit  have  been  discussed  and  it  may  be  well 
to  consider  briefly  the  effects  of  each. 

250.  Effect  of  non-circulating  credit. — The  use  of 
non-circulating  credit  (promissory  notes)  has  very  little 
effect  on  prices  through  any  economy  of  the  use  of 
money  which  it  brings  about  per  se.     Such  credits  must 
be  settled  at  maturity  in  money.     Hence  the  use  of 
money  is  postponed  rather  than  obviated.     It  must  be 
remembered,  however,  that  the  use  of  non-circulating 


212  MONEY  AND  BANKING 

credit,  while  it  facilitates  production  and  thus  increases 
the  amount  of  transactions,  at  the  same  time  greatly  in- 
creases the  medium  by  its  creation  of  circulating  credit. 
The  manner  in  which  non-circulating  credits  are  con- 
verted by  the  banks  into  circulating  credits  had  already 
been  described.  Business  men  issue  promissory  notes, 
discount  them  at  the  bank  and  receive  in  exchange  bank 
credit  either  in  the  form  of  notes  or  deposit  accounts. 

It  is  this  deposit  currency  which  has  in  this  country 
removed  a  greater  part  of  the  burden  of  exchanging 
goods  from  the  shoulders  of  money  itself.  Probably 
75  per  cent  of  our  exchanges  are  performed  by  the  use 
of  checks  and  drafts  drawn  against  these  deposits. 
Money  must  be  held  by  the  banks  against  their  credits 
as  a  reserve  to  maintain  confidence  in  their  redemption, 
but  the  amount  needed  is  only  from  15  to  25  per  cent  of 
the  outstanding  credits.  These  checks  and  drafts,  while 
they  are  merely  promises  to  pay  money  and  theoretic- 
ally must  be  redeemed  in  money  are  so  cancelled  one 
against  the  other  that  little  actual  money  is  used. 

251.  Cancellation  of  credit. — For  example,  let  us 
take  an  isolated  community  in  which  there  are  two 
banks,  the  deposits  of  each  being  $100,000,  and  the 
money  reserves  $25,000.  A,  B  and  C  are  local  business 
men ;  A  and  B  have  deposit  accounts  with  one  bank  and 
C  with  the  other.  If  A  gives  his  check  to  B  in  pay- 
ment for  goods,  the  check  will  be  deposited  by  B  and 
his  account  will  be  credited  with  the  amount  of  the 
check,  while's  A's  account  will  be  charged.  Thus  goods 
have  been  exchanged  solely  by  credit.  If  A  gives  his 
check  to  C,  it  will  be  deposited  in  C's  bank,  and  theoretic- 
ally C's  bank  may  expect  A's  bank  to  pay  the  check  in 
money.  It  is  probable,  however,  that  each  bank  will 
hold  checks  drawn  on  the  other,  in  which  event  only 


EFFECT  OF  CREDIT  ON  PRICES 

the  difference  in  total  amounts,  of  balance  will  be  set- 
tled in  money.  In  this  manner  the  checks  are  cancelled 
one  against  the  other  without  any  use  of  money.  It  is 
obvious  that  in  large  communities  where  it  is  customary 
to  make  settlements  by  check,  that  this  cancellation  be- 
comes very  important.  How  very  important  this  cus- 
tom has  become  will  be  seen  when  the  functions  of  the 
clearing  house  are  discussed. 

252.  How  lessened  demand  for  money  causes  rise  in 
prices. — Thus  money  is  used  by  the  banks  only  as  a 
reserve  against  actual  withdrawals  of  money  and  for  the 
settlement  of  balances.     The  efficiency  of  the  dollar  is 
by  this  system  multiplied  several  times,  hence  the  de- 
mand for  money  is  lessened,  and  prices  tend  to  rise. 

The  use  of  this  form  of  credit  has,  moreover,  a 
further,  though  not  so  important,  influence  upon  prices. 
In  poorly  settled  communities  where  banking  facilities 
are  meagre  the  merchant  and  the  farmer  must  keep  on 
hand  in  their  cash  drawers  or  pockets  sufficient  money 
to  accomplish  their  purchases.  It  is  inconvenient  to 
make  payments  by  check;  in  fact,  if  they  did  so,  the 
check  would  probably  be  followed  by  the  delivery  of 
actual  money.  There  is  no  way  in  which  checks  can 
be  cancelled  against  each  other.  With  the  establishment 
of  banks  and  the  growth  of  the  checking  habit,  how- 
ever, the  necessity  for  carrying  about  large  amounts  of 
actual  money  is  overcome.  The  demand  for  money  is 
thereby  lessened,  and  prices  again  tend  to  rise. 

253.  Effect  of  national  bank  notes. — In  the  chapter 
on  the  nature  of  credit  the  difference  between  the  true 
bank  note  and  the  national  bank  note  was  described. 
Inasmuch  as  the  national  bank  notes  are  secured  by 
Government  bonds,  which  are  merely  long  time  Gov- 
ernment credits,  they  circulate  freely  as  money  itself. 


MONEY  AND  BANKING 

Their  effect  on  prices,  therefore,  corresponds  to  the 
effect  of  other  forms  of  Government  credit,  and  will 
be  discussed  under  that  heading. 

254.  Bank  notes  and  checks  differentiated. — It  has 
been  already  stated  that  the  difference  between  the  de- 
posit and  the  true  bank  note  is  one  of  form.  It  remains, 
however,  to  describe  the  difference  in  form  before  the 
effect  of  true  bank  notes  upon  prices  can  be  considered. 
The  chief  difference  is  that  the  bank  note  is  payable  to 
bearer,  whereas  checks  and  drafts — the  forms  in  which 
the  deposit  currency  circulates — are  usually  drawn  in 
favor  of  a  definite  payee.  Before  the  check  is  valuable 
it  must  be  endorsed  by  the  payee,  whereas  the  note  cir- 
culates without  endorsement.  Furthermore  the  value  of 
a  check  depends  upon  the  size  of  the  deposit  account 
possessed  by  the  maker  of  the  check.  Thus  checks  do 
not  circulate  as  freely  as  notes  because  both  personal 
and  bank  credit  are  involved.  They  usually  return  to 
the  bank  promptly  for  redemption,  whereas  notes  may 
remain  outstanding  for  considerable  periods. 

Because  notes  are  meant  for  wider  circulation  than 
checks,  they  have  been  generally  endowed  with  certain 
preferences  over  deposits  that  enable  them  to  meet  more 
readily  the  demand  for  hand  to  hand  money.  These 
banks  may  be  compelled  to  keep  a  larger  and  specific 
reserve  for  their  redemption,  or  perhaps  a  guarantee 
fund  with  the  Government;  or  as  in  this  country  the 
notes  may  be  a  first  lien  on  all  the  assets  of  the  bank  and 
be  secured  by  the  pledge  of  Government  bonds.  That 
there  is  danger  in  endowing  their  security  with  too  in- 
flexible provisions,  so  that  once  issued  they  become  a 
part  of  the  actual  money  supply  and  are  never  pre- 
sented for  redemption,  will  be  seen  when  our  own  bank 
note  system  is  decribed  in  a  subsequent  chapter. 


HI 

The  true  bank  note,  that  is,  one  which  is  not  secured, 
by  the  pledge  of  specific  assets  or  a  deposit  of  bonds  but 
by  the  general  credit  of  the  bank,  may  have  a  very  im- 
portant effect  on  prices.  For  example  let  us  suppose 
that  the  holder  of  deposit  credits  needs  money  for  hand 
to  hand  transactions.  Perhaps  he  is  going  away  where 
he  is  not  known  and  where  his  check  would  not  be  hon- 
ored. If  note  issue  were  greatly  restricted,  the  bank 
must  honor  his  credit  by  the  payment  of  actual  reserve 
money.  Under  a  system  of  free  note  issue  on  the  other 
hand,  no  money  would  be  needed;  the  bank  would  issue 
the  note  which  would  be  generally  acceptible  and  would 
remain  outstanding  only  as  long  as  there  was  demand 
for  it  as  a  medium  of  exchange.  Once  in  the  possession 
of  another  bank  it  would  be  presented  for  redemption 
because  money  is  more  valuable  to  bank  than  credit. 

The  use  of  the  bank  note  tends  to  raise  prices  by 
lessening  the  demand  for  money.  Its  chief  benefit, 
however,  arises  from  the  fact  that  it  so  often  prevents 
prices  from  falling  sharply  when  any  extraordinary  de- 
mand for  hand  to  hand  money  (such  as  we  are  apt  to 
have  at  certain  times  of  the  year  and  are  sure  to  have  in 
panics)  causes  a  depletion  of  bank  reserves  and  a  con- 
traction of  credit. 

255.  Effect  of  government  credit  money. — The  use 
of  Government  credit  money  and,  in  the  country,  of 
national  bank  notes,  has  practically  the  same  effect  on 
prices  as  a  similar  increase  of  actual  money.  When 
faith  in  the  redemption  is  entire,  and  when  it  is  made 
legal  tender  and  is  therefore  available  for  bank  reserves, 
an  increase  in  Government  credit  money  tends  to  raise 
prices  just  as  would  an  increase  in  gold  itself.  A  con- 
siderable issue  of  new  Government  credit  in  a  single 
country  will  in  fact  increase  prices  all  over  the  world. 


216  MONEY  AND  BANKING 

Its  first  effect  is  a  rise  of  prices  in  the  issuing  country. 
This  means  that  imports  will  increase,  and  exports  di- 
minish. Finally  gold  must  be  exported  in  settlement  of 
the  international  balance,  and  thus  gold  will  tend  to 
raise  prices  in  the  other  countries. 

256.  Credit  and  speculation. — The  use   of  credits, 
particularly  bank  credit  has  a  further  effect  on  prices 
in  that  it  fosters  speculation.     Speculation  is  that  sort 
of  buying  and  selling  which  does  not  help  to  move  goods 
along  the  channels  of  industry  and  commerce  from  the 
producer  to  the  consumer.     The  object  of  speculation  is 
gain  from  the  adventitious  fluctuation  of  price  and  not 
from  the  natural  increment  in  value  of  goods  arising 
from  increased  utility  as  they  approach  consumption. 
Legitimate  speculation  tends  to  equalize  supply  over 
long  periods  and  adapt  it  to  the  demand,  thus  decreas- 
ing fluctuations  of  price  and  distributing  its  effects  in 
the  least  harmful  way. 

Illegitimate  speculation  increases  fluctuations  of 
price,  either  through  trading  in  ignorance  of  conditions 
of  supply  and  demand  or  by  manipulating  the  market 
and  causing  temporary  changes  which  are  not  justified 
by  supply  and  demand.  It  makes  prices  abnormal, 
usually  abnormally  high  at  first,  followed  by  a  period 
when  they  are  abnormally  low. 

Bucket  shopping  and  mere  gambling  on  price  fluc- 
tuations are  not  referred  to  here;  though  reprehensible 
in  themselves  and  injurious  to  public  morals,  they  are 
innocent  of  any  effect  on  prices.  It  is  only  when  prop- 
erty is  actually  bought  and  sold,  when  the  demand  and 
supply  are  altered,  that  changes  in  price  result. 

257.  How  speculation  may  be  both  cause  and  effect  of 
a  rise  in  prices. — To  buy  property,  one  must  have  means 
of  payment.     Speculation  requires  that  the  speculator 


EFFECT  OF  CREDIT  ON  PRICES  217 

must  not  only  have  means  of  payment  but  that  he  must 
be  able  to  hold  property  out  of  the  market  for  a  time. 
In  speculation  then,  capital  instead  of  being  invested  in 
productive  enterprises  and  adding  to  the  supply  of 
goods,  is  locked  up  in  goods  hoping  to  profit  not  by 
productive  increases  but  merely  by  a  rise  of  price.  Pro- 
ductive profits  arise  from  an  increase  in  the  amount  or 
utility  of  goods;  speculative  profits  from  artificial 
scarcity  of  goods.  Speculation  is  both  the  cause  and 
effect  of  price  fluctuations;  a  natural  increase  of  price 
will  start,  often,  a  speculative  boom  which  soon  makes 
prices  abnormally  high. 

Credit  is  the  instrument  of  speculation.  It  furnishes 
the  medium  of  exchange  which  releases  prices  tempor- 
arily from  their  dependence  on  money,  and  permits 
them  to  soar.  It  enables  persons  with  small  capital  to 
purchase  and  hold  property.  If  credit  were  unknown 
and  every  exchange  of  property  required  money,  spec- 
ulation would  still  exist  on  a  small  scale;  none  but  cap- 
italists, however,  could  engage  in  it  and  the  money 
which  was  diverted  to  the  speculative  buying  of  one 
commodity  would  be  withdrawn  from  other  uses,  and 
the  prices  of  others  things  must  fall.  A  general  spec- 
ulative movement,  therefore,  would  be  impossible. 

So  far  we  have  spoken  of  the  effect  of  the  various 
forms  of  credit  only  as  compared  to  a  system  in  which 
credit  is  not  used.  This  was  equivalent  to  considering 
merely  the  effect  of  an  increase  or  expansion  of  credit. 
It  remains  therefore  to  examine  the  effect  of  prices  of 
a  contraction  of  credit. 

258.  Defect  of  our  currency  system. — Unfortun- 
ately this  is  the  great  defect  of  our  credit  system.  Un- 
like expansion,  which  is  gradual  and  always  takes  place 
in  answer  to  a  demand  for  money,  contraction  of  credit 


218  MONEY  AND  BANKING 

is  likely  to  be  very  sudden.  Moreover,  it  is  likely  to 
occur  after  a  long  period  of  expanding  credit  and  ris- 
ing prices ;  therefore  the  contraction  and  consequent  fall 
of  prices  will  be  the  more  acute. 

We  have  seen  that  credit  depends  on  confidence  that 
the  debtor  will  be  able  and  willing  to  meet  his  obliga- 
tions. If  anything  occurs  to  destroy  this  confidence, 
there  will  be  a  general  demand  for  payment.  More- 
over, it  does  not  always  take  some  great  political  up- 
heaval to  cause  this  disturbance,  particularly  if  credits 
are  greatly  expanded  and  prices  high.  Any  decided 
fall  in  prices  in  any  great  industry,  due  perhaps  to  con- 
ditions entirely  peculiar  to  that  industry,  may  cause  a 
general  slump  of  the  stock  market.  This  shrinkage 
in  values  causes  doubt  to  be  cast  on  the  ability  of  debtors 
to  pay,  and  such  credits  as  are  due  are  presented  for 
payment.  To  meet  these  obligations,  debtors  must  sell 
their  goods  and  property.  Since  no  one  cares  to  pur- 
chase, prices  decline  sharply,  to  be  followed  by  still 
greater  distrust,  lower  values,  further  selling  and  so  on, 
with  cumulative  effect.  This  process  continues  until  a 
large  portion  of  the  credits  have  been  liquidated. 

This  condition  is  not  attributable  to  credit  itself,  but 
to  our  particular  system.  The  great  desideratum  of  a 
credit  currency  is  elasticity — the  power  to  expand  when 
it  is  stretched  and,  what  is  more  important,  to  contract 
of  itself  when  the  pull  is  removed.  The  amount  of 
readily  acceptable  medium  of  exchange  should,  how- 
ever, expand  quickly  and  without  restrictions  when  a 
general  demand  for  liquidation  appears.  Hence  if  the 
banks  could  issue  notes  freely  in  times  of  panic,  a  vast 
amount  of  credits  might  be  liquidated  without  resort 
to  a  depletion  of  bank  reserves.  The  effect  of  liquida- 
tion on  prices,  therefore,  would  not  be  so  cumulative. 


EFFECT  OF  CREDIT  ON  PRICES  219 

It  should  not  remain  outstanding  longer  than  there  is 
an  actual  demand  for  it  as  a  medium.  When  times  are 
prosperous  and  profits  increasing  with  rise  in  prices, 
stocks  lend  themselves  readily  to  speculation  and  for 
that  reason  are  apt  to  be  abnormally  high. 

All  the  money  in  existence,  however,  cannot  be  said 
to  be  in  circulation,  and  hence  is  not  offered  for  goods 
at  any  one  time.  Besides  the  limitations  on  the  num- 
ber of  exchanges  which  the  average  dollar  can  make 
within  a  given  time,  it  frequently  happens  that  dollars 
are  hoarded  for  longer  or  shorter  periods ;  until  they  are 
again  put  into  circulation  they  might  just  as  well  be 
non-existent  so  far  as  their  effect  on  prices  is  concerned. 
Moreover,  the  amount  of  the  credit  medium  of  exchange 
which  is  offered  for  goods  constantly  varies. 


GOVERNMENT  CREDIT  CURRENCY 

259.  Classification  of  government  credit  currency. — 
A  large  amount  of  the  money  supply  of  the  United 
States  consists  of  Government  credit.     Under  this  head 
must  be  classed  the  greenbacks,  the  treasury  notes,  gold 
and  silver  certificates,  silver  dollars,  and  all  subsidiary 
coins.     These  are  all  forms  of  credit  money,  because 
they  derive  their  value  as  media  of  exchange  from  the 
Government's  ability  and  readiness  to  redeem  them  in 
gold  on  demand. 

It  is  obvious,  however,  that  they  do  not  all  depend 
equally  upon  the  Government's  general  credit.  Silver 
dollars  and  the  subsidiary  coins  possess  a  certain  value 
in  themselves  because  of  the  metal  they  contain.  Gold 
and  silver  certificates  are  mere  warehouse  receipts  for 
an  equivalent  amount  of  metal  held  in  the  treasury, 
and  depend  only  upon  the  safe  keeping  of  that  metal. 
The  greenbacks  and  treasury  notes  only  are  true  credit 
money. 

Credit  money  should  not  be  confused  with  fiat  money. 
We  have  already  noted  that  the  gold  dollar  derives  its 
value  both  from  the  metal  it  contains  and  from  the  de- 
mand for  it  as  a  medium  of  exchange.  Under  our  sys- 
tem of  free  coinage  the  supply  is  regulated  auto- 
matically. In  economic  speech,  the  gold  dollar  is  known 
as  commodity  money. 

260.  Fiat  money  defined. — Fiat  money,  on  the  other 
hand,  is  any  money  the  supply  of  which  is  regulated 

220 


GOVERNMENT  CREDIT  CURRENCY  221 

artificially  and  the  demand  for  which  is  the  result  of 
its  service  as  a  medium  of  exchange.  It  may  be  com- 
posed of  valuable  metal,  or  it  may  not;  in  any  event  it 
is  not  its  contents  or  convertibility,  but  its  exchange 
utility  that  fixes  its  value. 

Credit  money  is  a  promise  to  pay  either  fiat  or  com- 
modity money.  If  it  is  a  direct  promise  to  pay,  it  is 
said  to  be  redeemable,  at  least  as  long  as  the  promise 
is  kept ;  if  the  redemption  is  suspended  or  if  it  does  not 
depend  upon  a  direct  promise  to  pay,  but  upon  its  cus- 
tomary redemption  by  the  Government,  it  is  said  to  be 
irredeemable.  The  difference  between  irredeemable 
credit  and  fiat  money  is  that  the  good  faith  of  the  Gov- 
ernment is  pledged  to  the  redemption  of  the  former  in 
spite  of  a  period  of  suspension  and  its  value  will  always 
be  influenced  by  the  prospect  of  its  actual  redemption. 

261.  Factors  determining  the  value  of  credit  money. 
— Since  commodity  money  derives  its  value  both  from 
the  value  of  the  metal  it  contains  and  from  the  need  for 
it  as  a  medium  of  exchange,  credit  money  based  on  gold, 
whether  nominally  redeemable  or  not,  depends  for  its 
value  first,  upon  the  prospect  of  the  redemption  and 
second,  upon  the  supply  of  credit  money  relative  to  the 
exchanging  that  is  to  be  done. 

In  an  earlier  chapter  we  saw  how  the  greenbacks 
fluctuated  in  value  relatively  to  gold  during  the  Civil 
War  as  their  redemption  seemed  immediate  or  remote. 
This  was  not  the  sole  reason,  however,  for  their  fluctu- 
ation. Within  narrower  limits  the  relative  value  of 
greenbacks  to  gold  and  of  goods  to  greenbacks  fell 
with  each  additional  issue  of  notes.  This  can  hardly  be 
attributed  to  a  belief  that  the  new  issue  made  redemp- 
tion more  uncertain ;  if  the  Government  could  redeem  at 
all,  it  would  make  little  difference  whether  there  were 


MONEY  AND  BANKING 

50  or  100,000,000  more  notes.  It  can  more  reasonably 
be  attributed  merely  to  an  increase  of  the  money  sup- 
ply, which  in  itself  was  sufficient  to  raise  prices.  It  is 
impossible  to  reach  any  definite  conclusion  as  to  how 
much  of  the  fluctuation  was  caused  by  each  of  these  in- 
fluences, but  it  is  clear  that  they  were  both  at  work. 

In  fact,  when  after  1868  the  Government  suspended 
entirely  the  retirement  of  the  greenbacks,  they  con- 
tinued to  circulate  and  even  rose  rapidly  in  value.  Dur- 
ing the  year  that  followed  they  were  practically  fiat 
money,  drawing  their  value  solely  from  the  demand  for 
them  as  a  medium  of  exchange.  In  1869,  however, 
Congress  passed  what  is  known  as  the  Public  Credit 
Act,  pledging  their  redemption  in  coin,  so  that  they  re- 
sumed their  character  of  credit  money. 

262.  Risk  in  free  use  of  credit  money. — The  theory 
behind  the  issue  of  credit  money  is  that  it  economizes 
the  use  of  gold  and  prevents  price  fluctuations.     Its 
most  ardent  advocates  claim  that  it  can  become  the  sole 
medium  of  exchange  in  a  nation  where  confidence  in 
the  government  and  its  ability  to  redeem  in  gold  is 
maintained.     This  confidence  can  be  sustained  by  a  re- 
serve of  gold  upon  which  the  country  will  draw  only 
for  the  purpose  of  paying  for  imports.     Furthermore 
its  supply  can  be  regulated  and  adapted  to  the  varying 
needs  of  industry;  at  least  such  is  the  claim.     That  it  is 
a  dangerous  device,  however,  the  history  of  almost  every 
nation  shows. 

263.  Regulation    of    credit    money. — That    credit 
money  economizes  the  use  of  gold  is  evident;  hence  so 
far  as  it  can  be  issued  without  ill  effects,  it  must  be  a 
benefit  to  a  nation.     The  great  danger  is  in  its  regula- 
tion.    The  effect  of  any  issue  of  credit  money  on  prices 
and  on  the  money  supply  has  already  been  mentioned. 


GOVERNMENT  CREDIT  CURRENCY 

Prices  rise  because  there  is  more  circulating  medium; 
this  increases  imports  which  are  always  quick  to  take 
advantage  of  a  rise  in  price;  gold  flows  out  of  the  coun- 
try to  pay  for  the  imports.  Prices  then  fall  somewhat 
in  the  issuing  country  because  of  the  loss  of  gold,  and 
rise  abroad;  in  the  end,  world  prices  are  readjusted  on  a 
higher  level. 

This  will  take  place  whenever  there  is  an  issue  of 
credit  money,  whether  it  is  redeemable  or  irredeemable. 
As  long  as  the  issue  is  not  excessive,  that  is,  as  long  as 
the  amount  of  credit  money  issued  does  not  approach 
the  amount  of  gold  formerly  in  circulation,  its  effect  is 
not  dangerous.  When  the  issue  of  either  becomes  ex- 
cessive, so  that  all  the  gold  flows  out  in  payment  for  im- 
ports or  is  hoarded  in  expectation  of  such  a  condition, 
the  credit  money  becomes  the  standard  of  prices  and  the 
sole  medium  of  exchange. 

At  such  times  it  makes  little  difference  whether  the 
credit  money  is  nominally  redeemable  or  not.  Even  if 
it  is  redeemable  and  the  government  keeps  a  gold  re- 
serve for  the  purpose,  it  will  soon  be  depleted  because 
all  credit  money  issued  in  excess  of  the  monetary  de- 
mand will  promptly  be  presented  at  the  treasury  for 
redemption.  When  this  reserve  has  been  paid  out, 
credit  money  of  either  kind  becomes  irredeemable  in 
fact.  The  only  difference  between  the  two  forms 
seems  to  be  that  irredeemable  credit  will  drive  the  gold 
out  somewhat  faster.  When  the  government's  promise 
to  pay  is  express,  and  a  reserve  is  kept,  public  confi- 
dence in  the  redemption  will  last  longer,  so  that  hoard- 
ing will  not  start  as  soon.  In  other  words,  a  greater 
amount  of  redeemable  than  of  irredeemable  credit  can 
be  issued  with  safety. 

The  moment  that  credit  money  fails  to  circulate  at 


MONEY  AND  BANKING 

par  with  gold,  the  credit  money  is  said  to  be  depreciated 
currency.  This  will  take  place  long  before  all  the  gold 
has  been  driven  out  of  circulation.  The  standard  of 
prices  will  be  a  double  one ;  goods  will  be  priced  so  much 
for  gold,  and  a  greater  amount  for  the  credit  money. 

264.  Devices  to  maintain  value  of  credit  money. — It 
has  been  the  history  of  credit  money  that  efforts  are 
usually  made  to  keep  the  credit  circulating  at  par  with 
gold  by  making  it  legal  tender.     This  means  that  it 
must  be  accepted  in  payment  of  all  debts.     While  this 
feature  increases  its  efficiency  as  money,  and  theoretic- 
ally makes  it  a  more  perfect  substitute  for  gold,  it  is 
difficult  to  understand  how  it  prevents  its  depreciation. 
We  have  seen  that  the  value  of  credit  money  depends 
first  upon  the  prospect  of  its  redemption  and  second 
upon  its  supply  relative  to  the  money  work  which  is  to 
be  done.     The  legal  tender  stamp  does  not  increase  the 
prospect  of  redemption  of  redeemable  credit,  because 
for  that  the  government's  faith  is  already  definitely 
pledged. 

It  is  only  when  credit  money  is  irredeemable  that 
making  it  legal  tender  to  prevent  depreciation  is  bene- 
ficial. In  this  case,  the  government  is  not  already  def- 
initely pledged  to  redeem  the  credit,  hence  anything 
attached  to  it  which  is  an  evidence  of  the  government's 
good  faith  increases  public  confidence  in  its  redemption. 
The  promise  to  accept  it  in  payment  of  debts  to  itself  is 
obviously  an  evidence  of  its  purpose  to  redeem. 

265.  Argument  for  government  credit  money. — It 
must  be  admitted  in  support  of  those  theorists  who  ad- 
vocate  the   use   of   government   credit   as   the    "ideal 
money"  that  it  has  been  tried  usually  under  the  most 
inauspicious  circumstances,  its  issue  generally  having 
been  resorted  to  only  to  finance  wars  or  to  maintain 


GOVERNMENT  CREDIT  CURRENCY  225 

prosperity  which  has  already  grown  unhealthy.  If  it 
could  be  issued  with  the  sole  aim  of  steadying  prices 
under  conditions  which  would  necessitate  its  redemption 
when  the  need  for  it  disappeared,  it  might  become  a 
very  effective  instrument  in  the  hands  of  a  competent 
government. 

Its  issue  on  this  theory  is  impracticable,  however,  be- 
cause automatic  redemption  is  impossible.  When  con- 
fidence in  the  government  is  general,  all  forms  of  credit 
issued  by  it  find  their  way  into  the  channels  of  trade, 
causing  a  rise  of  prices.  As  long  as  confidence  is  main- 
tained, they  will  continue  to  be  a  part  of  the  money  sup- 
ply because  there  is  no  motive  for  their  redemption. 

266.  Difficulties  of  adjusting  supply. — Moreover,  it 
would  be  unsafe  to  give  to  Congress  or  to  any  associa- 
tion of  bankers  the  power  to  expand  and  contract  the 
money  supply  artificially.  Congress  is  not  always  well 
informed  of  the  business  needs  of  the  country;  and 
bankers  must  always  have  personal  and  selfish  interests. 
The  effect  of  a  sudden  contraction  of  the  money  supply 
as  seen  in  panics  is  well  known.  Moreover,  the  power 
to  regulate  the  money  supply  would  include  the  power 
to  inflate  or  depress  the  price  level.  We  are  forced  to 
the  conclusion,  therefore,  that  this  credit  has  been  well 
named  "ideal  money"  by  the  theorists;  "ideal"  because 
it  presupposes  a  state  of  technical  knowledge  on  the  part 
of  legislative  bodies  and  absence  of  self-interest  which 
we  may  expect  with  the  millennium. 

Irredeemable  credit  money  may  circulate  at  par  with 
gold  if  the  issue  is  not  excessive  and  if  there  is  general 
confidence  in  the  government.  In  this  case  the  govern- 
ment has  not  promised  to  redeem  the  money,  but  it  does 
so  in  practice,  receiving  it  itself  at  par  with  gold.  This 
is  not  fiat  money  because  it  derives  its  value  not  entirely 

VII— 15 


226  MONEY  AND  BANKING 

from  its  exchange  utility  but  from  the  government's 
actual  redemption.  The  silver  dollar  is  a  good  ex- 
ample. 

Unfortunately,  however,  government  credit  money 
has  seldom  been  issued  in  response  to  a  demand  for 
money  as  a  medium  of  exchange.  It  has  been  issued 
largely  in  response  to  the  fiscal  needs  of  governments, 
that  is,  to  meet  extraordinary  increases  in  current  ex- 
penditures. 

267.  Prejudices  against  government  credit  money 
before  1861. — This  has  been  especially  true  of  the 
United  States.     The  Constitution  gave  Congress  the 
power  "to  borrow  money  on  the  credit  of  the  United 
States";  also  "to  coin  money  and  regulate  the  value 
thereof."     In  the  Constitutional  Convention  a  proposi- 
tion to  enable  Congress  "to  emit  bills  of  credit  was  de- 
feated, it  being  the  sense  of  the  Convention  that  paper 
money  was  dangerous."     The  history  of  the  Govern- 
ment shows  that  the  dislike  of  paper  money,  no  doubt 
a  survival  of  the  days  of  the  Revolutionary  bills  of 
credit,  must  have  continued  until  1861.     On  only  three 
occasions  prior  to  this  time  had  treasury  notes  been  is- 
sued, namely,  during  the  War  of  1812,  the  panic  of 
1867  and  the  Mexican  War  of  1847.     Moreover,  the 
aggregate  of  these  issues  amounted  to  only  $110,000,- 
000,  and  in  every  case  the  notes  were  interest-bearing, 
and  never  attained  general  circulation. 

268.  Financing  the  Civil  War. — The  opening  of  the 
Civil  War  brought  extraordinary  conditions.     Money 
must  be  raised  at  once  for  conducting  the  war,  and  in 
large  sums.     Should  the  Government  "borrow  money 
on  the  credit  of  the  United  States,"  or  should  it  create 
money  by  issuing  its  notes  and  endowing  them  with  the 
legal  tender  feature?     The  former  it  was  empowered 


GOVERNMENT  CREDIT  CURRENCY  227 

to  do  by  the  Constitution  and  could  have  done  by  the 
sale  of  bonds.  Government  bonds  are  a  form  of  gov- 
ernment credit,  but  they  are  not  credit  money,  as  they 
are  not  payable  on  demand.  The  market  for  bonds  was 
not  good,  however,  and  Congress  chose  the  latter 
method  as  less  expensive,  though  the  constitutionality 
was  very  doubtful.  It  may  be  objected  that  "the  power 
to  borrow  money"  included  the  right  to  issue  notes. 

In  regard  to  this  point,  the  distinctions  between  cap- 
ital and  money  must  be  kept  in  mind.  From  the  busi- 
ness man's  standpoint  what  the  Government  really 
needed  was  working  capital.  No  business  man  would 
think  of  issuing  demand  obligations  in  exchange  for 
capital  goods,  particularly  when  there  was  no  prospect 
of  an  immediate  increase  of  revenue  with  which  to  meet 
the  obligations.  The  business  man's  obligations  is- 
sued under  such  circumstances  would  be  long-time  cred- 
its in  the  form  of  bonds.  Furthermore,  there  was  no 
necessity  for  an  increase  in  the  money  supply.  Prices 
were  sufficiently  high.  What  the  Government  wanted 
was  not  money  but  purchasing  power  and  this  it  could 
have  borrowed  without  increasing  the  supply  of  money 
itself. 

269.  Disadvantage  of  government  debt. — Govern- 
ment credit  always  represents  a  government  debt.  In 
this  country  we  have  become  so  accustomed  to  having 
a  government  debt  that  its  elements  of  weakness  are  sel- 
dom analyzed.  Our  prosperity  orators  point  with  pride 
to  the  fact  that  the  United  States  is  the  only  nation  in 
the  world  which  can  sell  bonds  that  pay  only  2  per 
cent  interest.  This  is  applauded  as  an  evidence  of  pros- 
perity, without  analysis,  with  no  thought  that  the  very 
presence  of  a  debt  on  the  books  of  anyone,  even  of  a 
nation,  must  always  be  a  weakness.  In  what  respect 


228  MONEY  AND  BANKING 

should  a  government's  financial  activities  differ  from 
those  of  a  well-regulated  business?  Do  not  the  same 
principles  underlie  them  both? 

The  business  man  will  not  borrow  until  he  has  already 
devised  a  time  and  method  of  payment.  As  we  have 
already  noted,  the  form  in  which  he  will  borrow  depends 
upon  the  disposition  he  wishes  to  make  of  the  credit. 
If  he  expects  to  add  to  his  fixed  capital,  he  will  borrow 
by  issuing  long-time  credits,  expecting  either  to  pay 
them  out  of  his  profits  or  to  renew  them  at  maturity. 
If  he  merely  wants  the  use  of  funds  for  a  short  time, 
he  will  issue  short-time  or  demand  credits.  These  he 
will  expect  to  meet  out  of  the  proceeds  of  his  sales. 

270.  Government  debt. — When  a  government  bor- 
rows it  does  so  for  current  expenditures.  These  may 
be  for  permanent  improvement,  such  as  federal  build- 
ings, harbors,  canals,  which  will  benefit  the  public  gen- 
erally and  the  cost  of  which  should  be  spread  over  the 
period  of  their  usefulness  rather  than  be  met  out  of  the 
revenue  of  a  single  year  at  the  time  of  expenditure. 
A  favorite  expression  is  "to  let  posterity  have  its  share 
of  the  burden."  The  government  bonded  debt  in  1870 
amounted  to  $2,331,169,956;  in  1902  it  had  been  re- 
duced to  $925,011,639. 

The  income  of  a  government  is  generally  spoken  of 
as  revenue  and  is  derived  entirely  from  various  methods 
of  taxation.  If  we  wish  to  carry  out  the  analogy  be- 
tween the  government  and  the  business  man,  we  may 
say  that  the  differences  between  the  revenue  and  ex- 
penditures in  any  one  year  are  profit,  and  that  it  is 
with  this  profit  that  the  bonds  are  retired.  The  issue 
of  bonds,  therefore,  when  the  proceeds  are  not  squan- 
dered, rests  on  a  firm  business  basis. 


GOVERNMENT  CREDIT  CURRENCY          229 

The  issue  of  credit  money,  however,  presents  diff er- 
ent  problems.  When  the  business  man  issues  demand 
credits  he  purchases  something  salable  with  the  pro- 
ceeds, and  expects  to  be  in  a  position  to  retire  the  credit 
at  any  time.  The  government  on  the  other  hand  merely 
spends  the  money,  usually  to  meet  some  extraordinary 
expenses,  and  then  has  nothing  to  show  for  it.  If  it  is 
a  war  that  has  been  financed,  as  in  the  case  of  our  green- 
backs, it  had  a  perfect  right  to  borrow  for  the  purpose 
just  as  it  would  have  to  make  permanent  improvements 
because,  on  the  same  theory,  posterity  should  help  bear 
an  expense  from  which  it  will  benefit.  If  it  does  that, 
however,  a  provision  for  redemption  on  demand  must 
be  made  by  the  establishment  of  a  sufficient  gold  re- 
serve; but  to  rest  on  a  business  basis,  more  is  necessary. 
Posterity  should  not  bear  the  burden  by  keeping  the  re- 
serve always  intact  but  by  actually  retiring  the  demand 
credits.  Redemption  in  gold  on  demand  is  not  suffi- 
cient. These  credits  should  be  canceled  just  as  the 
bonds  have  been  canceled. 

271.  Demand  debts  a  weakness. — A  debt  is  always  a 
weakness,  but  especially  so  when  payable  on  demand. 
It  may  be  well  to  examine  the  claim  made  by  the  advo- 
cates of  the  issue  of  greenbacks  that  their  issue  would 
result  in  a  saving  to  the  government.  The  argument 
that  turned  the  tide  of  battle  in  Congress  was  that  in- 
terest-bearing bonds  could  be  sold  only  at  a  considerable 
discount,  whereas  the  non-interest-bearing  notes  could 
be  issued  at  par;  in  other  words,  a  large  saving  was  to 
be  effected  in  the  interest  account. 

In  an  earlier  chapter  the  preference  of  business  men, 
who  deal  in  goods  which  are  not  always  marketable,  for 
long  over  short  time  debts  was  pointed  out.  Further- 


230  MONEY  AND  BANKING 

more,  it  was  shown  that  they  will  often  pay  a  higher 
rate  of  interest  on  long  time  loans  simply  to  make 
their  business  more  secure.  A  good  example  of  the 
preference  has  been  shown  by  the  issue  of  $30,000,000 
in  bonds  by  Armour  &  Company  of  Chicago.  These 
bonds  bear  4%  per  cent  interest  and  were  issued  when 
the  commercial  rate  was  less  than  4  per  cent  in  spite 
of  the  fact  that  Armour  &  Company  always  had  a 
ready  market  for  their  short  time  credits  owing  to  their 
reputation  and  the  quick  convertibility  of  their  product. 

The  government  does  not  deal  in  goods  at  all.  Its 
only  method  of  meeting  obligations  is  by  doing  so  out 
of  its  excess  of  revenue  over  expenditures  or  by  re- 
funding them.  The  first  must  always  be  a  slow  process. 
In  its  ability  to  refund  only  does  the  government  have 
an  advantage  over  the  business  man;  and  even  this 
ability  may  be  crippled  at  critical  times,  so  that  in  re- 
funding a  loss  greater  by  far  than  the  interest  orig- 
inally would  result.  It  is  obvious,  therefore,  that  the 
proper  business  policy  would  be  to  avoid  the  issue  of 
demand  credits,  in  spite  of  the  original  saving  of  in- 
terest. 

272.  Provisions  for  retiring  debt. — In  any  event, 
however,  whether  a  debt  so  incurred  is  in  the  form  of 
bonds  or  notes,  provision  for  its  cancellation  should  be 
made.  The  smaller  the  debt,  the  greater  the  nation's 
borrowing  power;  and  there  is  no  telling  when  this  bor- 
rowing power  may  be  needed.  It  is  not  a  correct  busi- 
ness policy  to  allow  a  debt  incurred  during  one  period 
of  stress  to  remain  outstanding  to  reduce  the  govern- 
ment's credit  when  another  period  of  stress  appears.  It 
should  be  paid  off  in  prosperous  years,  so  that  when  an- 
other calamity  comes  the  slate  will  be  clean  and  the  gov- 
ernment's credit  unimpaired. 


273.  Productive  industries  classified. — The  economic 
life  of  a  community  consists  in  the  production  and  con- 
sumption of  goods.  The  production  of  goods  becomes 
more  difficult  and  complicated  as  the  wants  of  men 
grow  and  a  great  number  of  auxiliary  institutions  be- 
come necessary.  Banking  is  one  of  these  institutions, 
developed  to  assist  in  the  production  of  goods. 

The  institutions  which  carry  on  the  process  of  pro- 
duction may  be  classified  in  three  groups. 

1.  Those  whose  purpose  it  is  to  extract  raw  materials 
from  the  earth  and  to  adapt  these  raw  materials  to 
human  wants — therefore,  the  activities  of  agriculture, 
mining,  manufacturing,  etc. 

2.  Those  whose  purpose  it  is  to  transport  materials  and 
finished  goods  to  the  place  where  they  can  be  most  ad- 
vantageously used. 

3.  Those  whose  purpose  it  is  to  assist  in  transferring 
the  ownership  of  materials  and  finished  goods  so  that 
they  may  come  into  the  possession  of  those  persons  who 
can  use  them  most  advantageously — therefore,  the  ac- 
tivities of  retail  and  wholesale  merchandising,  broker- 
age, coining  and  issuing  money,  banking,  etc.     This 
third  group  of  economic  activities  is  not  absolutely] 
necessary  to  the  economic  process  but  is  a  consequence 
of  the  private  ownership  of  materials  and  the  means 
of  production ;  under  a  thorough  socialistic  regime  these 
institutions  would  be  superfluous. 

231 


232  MONEY  AND  BANKING 

274.  Recapitulation  of  fundamental  principles.— 
Under  our  present  system  of  private  ownership  of 
wealth  and  the  division  of  labor  in  production,  frequent 
transfers  of  ownership  are  required.  Exchange  is  an 
absolute  prerequisite  to  any  but  the  most  primitive 
form  of  production.  Only  an  insignificant  portion  of 
the  goods  produced  are  consumed  by  the  producer ;  they 
were  made  to  be  exchanged  for  other  goods.  In  the 
process  of  manufacture  most  goods  change  hands  many 
times  before  reaching  the  consumer. 

These  elementary  economic  facts  are  recapitulated 
for  the  purpose  of  emphasizing  the  importance  of  ex- 
change in  our  economic  life.  Under  an  economic  sys- 
tem of  private  property  there  could  be  no  civilization 
without  the  means  of  exchanging  one  form  of  property 
for  another. 

The  exchange  of  one  goods  for  another,  however, 
involves  considerable  difficulty.  In  any  exchange  there 
must  be  two  parties,  each  desiring  the  article  which  the 
other  wishes  to  part  with,  at  the  same  time  and  place. 
These  conditions  must  coincide  in  order  to  make  an  ex- 
change possible.  These  obstacles  in  the  way  of  barter 
led  early  to  the  use  of  money,  which  was  a  commodity 
enjoying  so  universal  a  demand  that  everybody  was 
willing  to  accept  it  in  exchange  for  his  goods. 

In  order  that  production  shall  be  most  successfully 
carried  on — that  is,  that  goods  of  the  highest  quality 
shall  be  produced  in  the  largest  quantity,  it  is  necessary 
that  each  person  shall  be  set  to  do  the  thing  at  which 
he  is  the  most  skillful  and  that  he  shall  be  able  to  make 
use  of  the  proper  tools  and  materials.  It  is  necessary 
that  the  capital  resources  and  the  labor  force  of  the 
country  should  be  brought  together  and  organized  in 
the  most  efficient  way.  The  number  of  persons  who 


ECONOMIC  FUNCTION  OF  THE  BANK         233 

are  capable  of  becoming  organizers  of  industry — entre- 
preneurs— is  limited,  and  these  are  not  usually  the  own- 
ers of  capital.  If  the  community  is  to  utilize  the  expert 
abilities  of  these  capable  but  propertyless  entrepreneurs, 
a  method  must  be  provided  by  which  they  may  come 
into  possession  of  capital  without  being  required  to  give 
an  equivalent  value  immediately.  So  we  have  the  insti- 
tution of  credit,  which  is  the  third  step  in  the  develop- 
ment of  exchange — barter,  money,  and  credit. 

275.  Credit. — A  credit  is  a  deferred  payment.     In 
exchange  for  valuable  property,  one  of  the  parties  to 
the  transaction  gives  his  promise  to  pay  a  certain  sum 
of  money  in  the  future,  or,  in  other  words,  he  gives  his 
creditor  the  right  to  receive  a  certain  sum  at  a  future 
time.     The  value  of  this  right  depends  of  course  upon 
the  certainty  of  payment  at  the  future  time.     This  de- 
pends further  upon  the  character  and  ability  of  the 
debtor  and  upon  the  aid  afforded  by  the  law  in  enforcing 
payment.     A  credit,  therefore,  is  a  contract  to  pay 
money,  and  is  usually  evidenced  by  a  written  instrument 
for  the  further  protection  of  the  creditor  and  for  the 
purpose  of  making  the  contract  negotiable.     The  fact 
that  credits  in  the  form  of  negotiable  instruments  are 
transferable  add  enormously  to  their  utility  as  media 
of  exchange. 

276.  Bank  a  dealer  in  credits. — The  business  of  a 
bank  is  to  deal  in  credits ;  it  is  a  market  for  the  purchase 
and  sale  of  credits.     It  is  an  institution  the  function 
of  which  is  to  assist  in  the  exchange  of  goods  by  facili- 
tating the  use  of  credit  as  a  medium  of  exchange.     It 
is  with  credit  as  with  any  salable  commodity — the  exist- 
ence of  a  market  where  it  may  be  bought  and  sold 
increases  its  use  because  a  demand  for  it  is  always 
assured.     Banks  are  an  economic  benefit  to  the  commu- 


MONEY  AND  BANKING 

nity  to  the  extent  that  they  promote  the  exchange  of 
goods  and  services,  to  the  end  that  the  material  resources 
(capital)  and  the  labor  force  shall  be  most  advanta- 
geously employed  in  the  best  possible  organization  and 
that  the  finished  products  shall  find  their  way,  with  the 
minimum  of  delay  and  difficulty,  to  the  best  markets. 

Every  exchange,  excepting  mere  barter,  involves  the 
use  of  a  medium  of  exchange.  Money  and  credit  are 
the  two  media  of  exchange.  The  term  "money"  is  now 
used  by  economists  to  mean  simply  the  standard  of  value 
which,  in  most  countries  to-day,  is  gold.  Where  the 
gold  standard  prevails,  all  other  forms  of  currency — 
token  coins,  government  notes  and  bank  notes — are 
credit  currency.  The  government  usually  undertakes 
to  provide  and  regulate  the  metallic  coinage  of  the  coun- 
try, but  leaves  to  the  banks  the  task  of  providing  and 
handling  the  credit  currency.  The  United  States  goes 
further  than  most  European  countries  in  concerning 
itself  with  the  credit  currency  of  the  country  by  issuing 
"greenbacks,"  and  Treasury  notes,  and  by  guaranteeing 
the  redemption  of  national  bank  notes. 

In  England,  as  well  as  in  most  of  the  larger  Euro- 
pean countries,  to  the  banks  is  delegated  the  function 
of  managing  the  credit  currency;  of  course,  under  re- 
strictions more  or  less  stringent.  The  point  to  be 
observed  in  this,  and  one  which  has  been  urged  by  sev- 
eral of  our  recent  writers  on  money,  notably  Conant  in 
his  "Principles  of  Money  and  Banking,"  is  that  the 
handling  of  credit,  even  of  credit  currency,  is  properly 
a  banking  function  rather  than  a  governmental  one. 

Credit  as  a  medium  of  exchange  varies  in  form  all 
the  way  from  a  national  bank  note,  which  passes  from 
hand  to  hand  as  freely  as  a  gold  coin,  to  a  mere  verbal 
promise  to  pay  evidenced  by  a  memorandum  in  a  ledger 


ECONOMIC  FUNCTION  OF  THE  BANK         235 

which,  often  as  it  has  served  in  one  exchange,  is  but 
rarely  negotiated  further.  Arranged  in  the  order  of 
their  negotiability  (their  serviceability  as  media  of  ex- 
change) between  these  two  extremes,  we  have  the  cer- 
tified check,  check,  draft,  bond,  promissory  note,  etc. 

277.  Banks  supply  a  medium  of  exchange. — Banks 
perform  the  function  of  supplying  a  medium  of  ex- 
change in  two  ways:  (1)  by  the  issue  of  paper  money, 
intended  for  general  circulation,  as  the  national  bank 
notes,  and  (2)  by  granting,  in  exchange  for  a  cash  de- 
posit or  an  interest-bearing  note,  its  own  credit  which 
can  be  used  by  the  customer  as  means  of  payment  by 
drawing  a  check  against  the  bank. 

The  function  of  providing  a  medium  of  exchange 
for  a  community  is  essentially  a  public  one  and  is  pecul- 
iarly liable  to  abuse  if  left  without  restriction  in  the 
hands  of  private  parties.  Before  the  Civil  War  this 
country  suffered  severely  from  badly  regulated  issues 
of  bank  money  and,  since  the  National  Bank  Act,  the 
right  to  issue  paper  money  has  been  limited  to  national 
banks  under  very  strict  regulations. 

278.  Banking  is  a  quasi-public  function. — The  right 
to  furnish  a  medium  of  exchange  by  the  system  of  checks 
and  deposits  still  belongs  to  every  bank,  but  in  all  cases 
it  is  regulated  either  by  federal  or  state  statutes.     Min- 
imum cash  reserves  are  required  to  be  kept  and  in  many 
other  ways  the  public  nature  of  the  business  is  recog- 
nized. 

Besides  the  quasi-public  function  of  providing  a  me- 
dium of  exchange  by  the  use  of  credit  in  one  form  or 
another,  banks  have  another  function  closely  allied  to 
it  and  sometimes  scarcely  to  be  distinguished  from  it — 
to  supply  temporary  capital  to  industry  in  the  form  of 
short  time  loans. 


236  MONEY  AND  BANKING 

In  this  age,  scarce  any  industry  can  be  carried  on 
without  capital.  It  is  very  rare  also  that  the  best  pro- 
motors  and  managers  of  industry  are  the  proprietors 
of  the  large  amounts  of  capital  necessary  to  carry  on 
the  business.  On  the  other  hand,  a  large  portion  of  the 
country's  capital  is  in  the  hands  of  those  who  have  no 
ability  to  employ  it  successfully  or  it  is  scattered  about 
among  the  people.  To  get  this  capital  into  the  hands 
of  the  entrepreneurs  who  can  employ  it  most  profitably 
is  a  function  largely  assumed  by  banks. 

279.  The  bank  a  distributor  of  capital. — Capital  is 
employed  in  industry  in  two  ways.  Some  of  it  must  be 
invested  in  the  plant  and  machinery;  this  is  fixed  cap- 
ital. Another  installment  must  be  invested  in  materials, 
labor,  incidental  expenses  of  production,  etc.,  the  neces- 
sity for  which  arises  out  of  the  length  of  time  required 
to  manufacture  and  market  the  product.  There  is 
naturally  great  variation  in  the  length  of  the  period 
of  production  in  the  various  industries.  In  some  of 
them  this  circulating  capital  must  be  tied  up  for  weeks, 
in  others  for  years. 

The  distinction  between  circulating  and  fixed  capital 
is  that  the  former  after  a  period  reappears  in  the  form 
of  a  salable  product  from  which  is  realized  the  value  of 
capital  invested  and  something  more  in  such  shape  that 
it  can  be  reinvested;  in  other  words  it  is  fluid,  whereas 
fixed  capital  remains  in  the  form  in  which  it  is  invested 
and  only  becomes  fluid  as  a  replacement  or  depreciation 
fund  is  accumulated  or  the  plant  is  sold. 

This  distinction  has  great  value  in  the  science  of 
banking,  for  as  we  shall  see  later,  the  credit  which  a 
bank  loans  has  a  very  precarious  existence  and  it  may 
become  necessary  to  withdraw  it  at  any  moment  from 
the  enterprise  in  which  it  is  invested.  The  restrictions 


ECONOMIC  FUNCTION  OF  THE  BANK        237 

which  legislation  has  placed  upon  the  manner  of  loans 
a  bank  may  make  are  really  based  upon  this  principle. 

280.  Banking  principle. — A  large  proportion  of  the 
bank  failures  of  the  country  is  caused  by  a  violation  of 
this    fundamental   banking   principle.     The    National 
Bank  Act  forbids  banks  to  loan  on  real  estate  or  mort- 
gages.    The  idea  back  of  this  is  to  prevent  the  locking 
up  of  funds  in  fixed  capital.     The  failure  of  the  three 
Walsh  banks  in  Chicago  in  1906  occurred  because  the 
funds  of  the  banks  had  been  used  to  build  railroads 
which  some  day  may  be  very  profitable,  but  which  for 
the  present  tie  up  capital  where  it  cannot  be  easily 
turned  into  a  means  of  payment. 

The  reasons  why  bank  funds  should  not  be  tied  up  in 
the  form  of  fixed  capital  are : 

( 1 )  The  value  of  the  investment  may  be  unstable. 

(2)  The  value  of  the  investment  may  depend  on  the 
completion  of  the  whole  plant,  as  in  the  case  of  the 
Walsh  railroads. 

(3)  The  value  of  the  investment  may  depend  upon 
a  monopoly  or  upon  the  ability  of  one  man,  so  that  if 
the  peculiar  advantage  ceases  to  exist  the  property 
shrinks  in  value.     New  processes  may  make  old  plants 
entirely  obsolete  and  destroy  their  value. 

281.  Double  function  of   commercial   banks. — The 
function  of  a  modern  commercial  bank  is  therefore  two- 
fold:    (1)   To  provide  a  means  of  payment  and  (2) 
to  provide  temporary  capital  for  the  use  of  industry. 
It  will  perhaps  be  well  to  show  briefly  how  these  func- 
tions were  developed. 

One  of  the  early  banks,  the  Bank  of  Amsterdam 
(1609),  was  practically  a  warehouse  for  coin.  Holland 
was  the  commercial  center  of  Europe  at  that  time,  and 
the  currency  in  circulation  was  a  heterogeneous  mass 


238  MONEY  AND  BANKING 

of  the  coinage  of  all  the  neighboring  and  distant  coun- 
tries, of  uncertain  value  and  frequently  mutilated. 
Such  a  currency  served  the  needs  of  commerce  very 
badly,  and  the  Bank  of  Amsterdam  was  organized  to 
relieve  the  difficulty.  It  received  deposits  of  this  mis- 
cellaneous currency,  calculated  its  value  on  the  basis  of 
a  fixed  standard  and  permitted  the  depositor  to  transfer 
his  credit  at  the  bank.  The  deposits  were  all  kept  in- 
tact in  the  bank,  or  at  least  were  supposed  to  be.  As 
a  matter  of  fact,  the  sight  of  so  much  idle  money  seem- 
ingly doing  no  good  to  anybody  in  time  proved  too 
strong  a  temptation  to  the  management  and  they  from 
time  to  time  permitted  large  sums  to  be  used  in  financ- 
ing hazardous  ventures,  principally  the  colonial  enter- 
prises of  the  Dutch  East  India  Company.  When  these 
facts  became  notorious  the  depositors  lost  faith  in  the 
bank  and  it  was  compelled  to  suspend.  This  bank  per- 
formed a  banking  function  in  that  it  provided  a  good 
medium  of  exchange,  but  it  did  not  deal  in  credit  in 
any  other  sense  than  a  grain  warehouse  man  who  is  sim- 
ply under  obligations  to  return  the  deposit  on  demand. 

In  the  Bank  of  England  (1694)  we  find  the  bank- 
ing functions  considerably  developed.  In  considera- 
tion of  a  loan  to  the  government,  which  at  that  time  was 
in  sore  need  of  funds,  the  subscribers  were  given  the 
exclusive  right  to  organize  a  bank  which  should  have 
the  privilege  of  issuing  notes  payable  to  the  bearer  and 
which  were  intended  to  circulate  as  currency. 

Here  we  have  the  essential  element  in  banking — an 
organization  which  is  able  in  some  way  to  create  credit 
at  small  expense  and  which  it  may  loan  out  to  the  public, 
deriving  an  income  therefrom  which  leaves  a  net  profit 
above  expenses.  In  other  words,  the  bank  is  able  to 


ECONOMIC  FUNCTION  OF  THE  BANK        239 

produce  something  cheaply  and  to  rent  it  out  at  a  cer- 
tain rate  per  cent.  The  following  features  were  a  part 
of  the  creation  of  the  credit  of  the  Bank  of  England: 

(1)  A  subscription  of  funds  which  should  be  loaned 
to  the  government  at  8  per  cent. 

(2)  Notes  must  be  printed,  counterfeiting  guarded 
against,  an  office  for  doing  business  and  redeeming  the 
notes  must  be  maintained. 

(3)  A  demand  for  currency  must  exist  so  that  the 
notes  will  remain  outstanding. 

282.  Peculiar  privilege  of  bankers. — There  are  a 
great  many  persons  and  firms  who  can  create  credit,  but 
the  banker  is  the  only  one  able  to  derive  an  income  from 
loaning  it  out.  The  reason  of  this  is  that  the  bank- 
credit  is  in  such  form  that  it  can  be  used  as  a  means  of 
payment  and,  therefore,  will  be  received  and  held  by 
the  public  so  long  as  there  is  need  for  it  to  do  the 
necessary  work  of  exchange. 

Naturally  a  business  in  which  the  stock-in-trade  can 
be  produced  at  very  little  expense  and  can  be  loaned 
out  at  from  5  per  cent  to  25  per  cent  per  annum  is 
peculiarly  attractive  and  liable  to  abuse.  Until  the  pas- 
sage of  the  National  Bank  Act,  the  United  States  had 
to  suffer  many  and  heavy  losses  through  the  insufficient 
regulation  of  this  important  function.  It  took  us  all 
those  years  to  learn  that  the  function  of  supplying  the 
currency  of  the  country  is  a  public  one  and  should  be 
delegated  to  private  parties  only  under  the  most  strin- 
gent regulations. 

Under  our  present  laws  the  privilege  of  issuing  bank- 
credit  to  be  used  as  currency  (the  national  bank  notes) 
costs  the  bank  nearly  as  much  as  the  income  derived 
from  loaning  the  notes  and,  furthermore,  a  large  part 


240  MONEY  AND  BANKING 

of  the  country's  need  for  credit  currency  is  supplied 
by  the  government  itself  by  issues  of  "greenbacks"  and 
Treasury  notes. 

By  far  the  largest  portion  of  the  payments  in  business 
transactions  are  made  by  the  use  of  credit  in  another 
form  than  currency,  that  is,  by  means  of  the  check  or 
draft.  The  service  of  the  banks  in  providing  currency 
is  really  insignificant  when  compared  to  their  service  in 
furnishing  a  method  of  payment  by  check. 

The  essential  element  in  the  check  system  is  the  same 
as  in  the  bank-note  system,  viz.,  bank  credit.  Instead 
of  selling,  or  more  properly,  loaning  its  credit  in  the 
form  of  bank  notes,  at  a  certain  rate  per  cent,  the  bank 
loans  the  right  to  draw  checks  against  it,  which  checks 
can  be  used  as  a  means  of  payment,  but  to  a  much  more 
limited  extent  than  bank  notes  and  with  a  much  more 
restricted  circulation.  The  principle  underlying  both 
systems,  however,  is  the  same. 

The  peculiar  characteristic  of  a  bank  is  the  privilege 
of  using  its  credit  as  a  medium  of  exchange.  This 
gives  its  credit  a  utility  enjoyed  by  the  credit  of  no 
other  organization  except  the  government.  Because 
its  credit  has  this  utility  it  can  be  kept  outstanding  with- 
out the  payment  of  interest.  The  principal  business  of 
the  bank  is  to  exchange  its  own  credit,  in  the  form  of 
bank  notes  or  a  deposit  credit  on  its  books  against  which 
checks  may  be  drawn,  for  the  credit  of  someone  else  in 
the  form  of  a  promissory  note  bearing  interest.  Under 
ordinary  circumstances  neither  the  bank  notes  nor  the 
deposit  credits  bear  interest,  consequently  the  bank  gains 
by  the  transaction  a  gross  profit  equal  to  the  interest 
on  the  promissory  note.  In  order  to  make  this  profit 
it  is  necessary  that  the  bank-credit  should  be  kept  out- 
standing and  not  be  returned  to  the  bank  for  payment. 


ECONOMIC  FUNCTION  OF  THE  BANK 

Credit  is  simply  a  deferred  payment  and  this  bank- 
credit  represents  a  payment  due  at  any  time  the  posses- 
sor chooses  to  call  for  it;  if  it  is  in  the  form  of  a  bank 
note  he  may  present  it  for  redemption  in  cash;  if  it  is 
in  the  form  of  a  deposit-credit  he  may  draw  a  check 
and  cash  it  at  the  bank.  Now,  if  bank  notes  were  re- 
deemed soon  after  their  issue,  or  if  deposit-credits  were 
checked  against  and  the  checks  cashed  soon  after  the 
credit  was  granted,  the  bank  would  not  be  able  to  keep 
its  credit,  having  no  interest  outstanding.  It  would 
gain  the  interest  on  the  promissory  notes  purchased  but, 
since  it  had  to  pay  cash  for  them  ultimately  by  redeem- 
ing the  outstanding  credit  given  for  them,  the  whole 
transaction  would  be  equivalent  to  loaning  money  at 
the  current  rate  of  interest,  nothing  more  or  less. 

In  actual  practice,  however,  the  bank  is  not  compelled 
to  redeem  its  credit  in  cash  immediately,  but  is  able  to 
keep  it  outstanding  for  some  time.  In  case  the  bank 
puts  out  its  credit  in  the  shape  of  bank  notes,  the  public 
need  for  currency  keeps  them  circulating  from  hand  to 
hand  and  serving  the  same  purpose  as  money;  as  there 
is  no  need  to  exchange  them  for  money  the  bank  is  not 
called  upon  to  redeem  them.  However,  this  no  longer 
applies  to  banking  in  the  United  States  since  the  privi- 
lege of  issuing  bank  notes  freely  has  been  taken  away 
from  the  banks  by  the  National  Bank  Act. 

Under  the  present  system  of  banking  in  this  country 
the  banks  can  no  longer  put  out  their  credit  in  the 
form  of  bank  notes,  except  in  the  case  of  national  bank 
notes  where  the  restrictions  upon  their  issue  are  so  many 
that  their  character  is  quite  changed;  they  no  longer 
represent  the  credit  of  the  issuing  bank  but  the  credit 
of  the  government  in  the  shape  of  a  United  States  bond. 
Having  been  deprived  of  this  one  method  of  keeping 

VII— 16 


MONEY  AND  BANKING 

their  credit  outstanding  by  the  issue  of  bank  notes,  the 
banks  have  made  use  of  another  method,  the  check  and 
deposit  system,  which  serves  the  same  purpose  but  which 
is  more  difficult  to  understand. 

283.  Banks  do  not  create  capital, — Dunbar  says  in  his 
little  book,  "The  Theory  and  History  of  Banking": 

It  is  obvious  that  the  bankers  create  no  new  capital  by  their 
lending  and  deposit  holding,  but  it  is  equally  plain  that  they 
direct  the  stream  of  capital  to  the  enterprises  and  industries  re- 
quiring such  support,  and  that  they  quicken  the  succession  of 
commercial  and  industrial  operations.  A  given  amount  of  cap- 
ital is  thus  made  more  effective,  so  that  the  result  of  the  introduc- 
tion of  banking  in  any  community  is  the  equivalent  of  a  consid- 
erable increase  of  capital,  although  not  implying  any  real  increase 
in  the  first  instance. 

Industry  is  impossible  without  two  things:  Capital 
and  management.  Very  frequently  the  class  of  per- 
sons owning  the  capital  are  not  capable  of  employing 
it  in  industry  to  the  best  advantage,  and  many  persons 
of  ability  have  no  capital.  It  is  the  function  of  the  bank 
to  bring  the  two  together  for  their  mutual  advantage 
and  thus  promote  industry. 

It  is  important  to  get  the  distinction  between  capital 
and  capital  goods.  Capital  goods  are  those  material 
things  which  are  employed  in  the  further  production 
of  goods,  such  as  machinery,  factory  buildings,  raw 
materials,  and  goods  in  the  hands  of  merchants.  Cap- 
ital is  a  certain  sum  of  value — so  many  dollars  worth — 
from  which  the  person  owning  it  expects  to  get  an  in- 
come. Capital  goods  wear  out  and  disappear,  but  cap- 
ital survives  in  the  form  of  replacement  and  sinking 
funds  under  normal  conditions. 


ECONOMIC  FUNCTION  OF  THE  BANK        243 

A  factory  may  be  turning  out  some  form  of  capital 
goods — machinery,  for  example — and  at  the  same  time 
there  may  be  entrepreneurs  desiring  to  make  use  of 
that  machinery  in  production  but  having  no  ready 
funds.  The  makers  of  the  machinery  cannot  part  with 
the  machinery  unless  they  get  some  form  of  medium 
of  exchange  with  which  to  pay  their  bills  for  wages, 
materials,  etc.  The  bank  steps  in  at  this  point  and 
enables  the  two  parties  to  get  together  to  the  advantage 
of  both  themselves  and  the  community.  The  machinery 
company  either  takes  a  note  from  the  entrepreneur  and 
gets  it  discounted  at  the  bank,  thus  changing  a  non- 
circulating  form  of  credit  into  a  medium  of  exchange 
with  which  they  can  pay  their  bills,  or  they  sell  the  ma- 
chinery on  time  and  borrow  from  the  bank  enough  to 
pay  running  expenses  until  the  account  shall  have  be- 
come due. 

Production  requires  a  lapse  of  time  and  the  owners 
of  the  capital  employed  must  wait  until  the  goods  pro- 
duced are  sold  before  they  can  get  back  their  capital. 
The  bank  takes  the  burden  of  waiting  from  those  who 
have  to  employ  their  capital  more  rapidly  and  places 
it  on  those  who  are  content  to  wait  so  long  as  they  get 
an  income  for  it. 

284.  Source  of  capital  and  credit  of  bank. — The 
sources  of  the  capital  and  credit  which  is  the  stock  in 
trade  of  the  bank:  (1)  Capital  stock  subscribed  by 
stockholders,  and  (2)  deposits  of  cash.  On  the  basis 
of  the  funds  thus  provided  the  bank  is  able  to  create  a 
large  amount  of  credit  which,  when  loaned  to  entrepre- 
neurs, serves  the  purpose  of  actual  capital  because  with 
it  they  can  purchase  the  capital  goods  they  require. 
Credit  is  a  substitute  for  money  in  making  exchanges 


MONEY  AND  BANKING 

and  may  be  compared  to  airships  which  in  the  near 
future  may  render  superfluous  railroad  tracks  and  right- 
of-way. 

285.  Operations  of  a  bank. — The  operations  of  a 
bank  are  three :  Discount  or  loaning,  deposit,  and  issue. 
In  discounting  or  loaning,  the  bank  buys  from  the 
customer  a  non-circulating  credit  in  the  form  of  a  prom- 
issory note  and  pays  for  it  with  cash  or,  what  is  much 
more  frequently  the  case,  with  its  own  credit  in  the  form 
of  bank  notes  or  a  deposit  credit,  either  of  which  are 
circulating  and  can  be  used  as  a  medium  of  exchange. 

In  dealing  with  the  bank  the  customer  may  either 
sell  (discount)  notes  of  other  people  which  he  has 
taken  in  trade,  or  he  may  sell  his  own  note  with 
these  trade  notes  as  collateral  security,  or  he  may 
sell  his  own  note  with  or  without  some  collateral. 
We  have  now  to  consider  what  it  is  that  the  bank 
gives  in  exchange  for  the  right  to  demand  and 
receive  money  at  a  future  time  which  is  acquired  by  it 
under  these  circumstances.  In  the  case  of  discount  the 
proceeds  of  the  discounted  note  (face  value  less  inter- 
est) are  placed  to  the  credit  of  the  customer,  to  be  drawn 
out  by  him  by  means  of  checks  to  suit  his  convenience. 
The  customer  has  given  the  bank  the  right  to  demand 
funds  from  him  at  a  definite  future  time  in  exchange 
for  the  right  to  demand  funds  from  the  bank  at  any 
time. 

The  item  "individual  deposits"  in  a  bank  statement 
does  not  imply  that  persons  have  deposited  cash  to  that 
amount  in  the  bank;  some  of  it  of  course  represents 
cash  deposited,  or  checks,  drafts,  etc.,  deposited  for  col- 
lection which  are  equivalent  to  cash;  but  the  greatest 
proportion  represents  credits  which  have  been  sold  by 


ECONOMIC  FUNCTION  OF  THE  BANK         245 

the  bank  in  exchange  for  non-circulating  forms  of  credit, 
i.  e.,  promissory  notes,  commercial  paper,  etc. 

A  bank  note  is  a  form  of  demand  liability  sold  by  the 
bank.  It  is  simply  the  evidence  of  the  debt  of  the  bank 
— the  same  as  an  entry  in  a  bank  book  showing  that 
whoever  possesses  it  can  claim  from  the  bank  a  certain 
sum.  The  system  of  checks  and  deposit  is  a  substitute 
for  bank  note  issues  and  developed  out  of  them.  Eng- 
land and  the  United  States  are  the  only  countries  mak- 
ing extensive  use  of  the  system,  the  continental  countries 
still  clinging  to  the  bank  note. 

In  the  operations  we  have  been  considering  the  sub- 
ject matter  involved  is  in  every  case  either  money  or 
contracts  for  the  payment  thereof,  viz.,  credit.  No 
form  of  dealing  in  merchandise  or  real  property  comes 
properly  within  the  field  of  banking. 

286.  Responsibility  of  the  banker  for  proper  distribu- 
tion of  capital. — Mr.  Conant  says  in  his  "Principles  of 
Money  and  Banking" : 

It  is  in  distributing  between  depositors,  borrowers,  and  his  own 
vaults  the  money  intrusted  to  him  by  depositors  in  such  a  man- 
ner that  he  shall  be  able  to  repay  it  according  to  his  promise, 
that  the  most  delicate  and  important  function  of  the  banker 
arises.  It  is  in  the  execution  of  this  function  that  the  modern 
banker  has  become  the  arbiter  of  the  direction  of  investment,  the 
organization  of  industry,  and  even  of  the  fate  of  nations.  Sim- 
ple as  the  process  is  by  which  the  banker  transfers  to  others  the 
stored  purchasing  power  which  he  has  gathered  up  in  small  de- 
posits from  his  customers  who  have  acquired  gold  or  the  right 
to  command  gold,  it  is  his  selection  among  these  borrowers  which 
determines  the  course  of  the  industrial  progress  of  the  nation. 

Hence  it  comes  that  the  banker,  in  the  financing  of  important 
enterprises,  can  within  certain  limits  determine  whether  a  given 
project  shall  succeed  or  fail.  In  every  growing  community 


246  MONEY  AND  BANKING 

much  of  the  real  burden  of  deciding  upon  the  course  of  its  future 
development  lies  with  the  banker.  It  is  for  him  to  determine 
the  relative  marginal  utility  of  one  enterprise  as  compared  with 
another  and  to  grant  his  support  to  the  enterprise  which  promise* 
the  highest  utility  and  therefore  the  most  certain  profits.  Thu§ 
there  rests  upon  the  banker  in  a  sense  the  vital  function  of  tru»- 
tee  for  the  community  in  its  dealings  with  itself.  This  trustee- 
ship is  especially  sacred  if  he  deals  with  the  money  of  others,  as  ia 
usually  the  case,  and  not  purely  with  money  of  his  own. 

The  peculiar  nature  of  a  bank  and  the  close  relation 
existing  between  it  and  the  economic  welfare  of  the 
community  is  brought  out  clearly  when  a  failure  occurs. 
In  the  case  of  an  enterprise  of  a  more  private  character 
— a  manufacturing  or  mercantile  concern — a  failure 
does  not  ordinarily  bring  such  disastrous  results  as  the 
failure  of  a  bank,  because  the  parties  injured  expected 
to  take  a  risk  and  usually  have  means  of  protecting 
themselves. 

A  bank  failure,  on  the  other  hand,  throws  a  direct 
loss  on  a  great  many  people  who  have  not  calculated 
on  any  risk.  Furthermore,  there  is  an  indirect  loss  of 
confidence  in  banks.  This  leads  people  to  withdraw 
their  deposits  and  go  back  to  the  more  primitive  and 
expensive  methods  of  exchange,  thus  retarding  the  eco- 
nomic development  of  the  country. 

Our  prosperity  is  owing  to  a  large  extent  to  the 
devices  which  make  exchange  easier  and  cheaper,  just 
as  better  railways  and  steamships  increase  our  welfare 
by  promoting  that  form  of  exchange.  Banking  de- 
vices, the  use  of  checks  against  deposits,  etc.,  are  just  as 
important  as  inventions  which  help  to  annihilate  dis- 
tance. 

The  banks  have  so  important  a  role  to  play  in  the 
disposition  of  the  circulating  capital  of  the  country  that 


ECONOMIC  FUNCTION  OF  THE  BANK 

they  can  cause  a  very  serious  complication  when,  by 
departing  from  the  true  rule  of  banking  and  in  hope 
of  gaining  large  profits,  they  invest  these  circulating 
funds  in  enterprises  of  a  speculative  character  and  by; 
so  doing  convert  circulating  into  fixed  capital* 


287.  Analysis  of  credit. — A  bank  loans  its  credit,  as 
a  general  rule,  rather  than  cash.  We  shall  have  to  prove 
this  statement,  for  the  average  banker  will  insist  that  he 
loans  cash. 

Credit  is  the  promise  to  pay  money  at  a  future  time 
and  arises  out  of  an  exchange  in  which  property,  serv- 
ices, or  some  valuable  thing  is  exchanged  against  a 
promise  to  pay  an  equivalent  value  in  the  future.  The 
transaction  is  not  complete  until  the  promise  is  dis- 
charged. A  credit  is  created,  therefore,  by  a  transfer 
of  value  which  is  still  incomplete,  one  of  the  parties  as 
yet  not  having  performed  his  part  of  the  contract;  in 
lieu  of  property,  the  second  party  gives  the  right  to 
receive  from  him  value  at  some  future  time.  Having 
been  once  created,  this  credit — this  right  to  receive  value 
— is  regarded  as  property  and  may  be  transferred  as 
any  other  form  of  property  is  transferred.  Whoever 
possesses  the  legal  right  to  receive  this  value  may  de- 
mand it  of  the  debtor  when  it  is  due. 

As  a  medium  of  exchange,  credit  is  superior  to  stand- 
ard money  in  that  it  does  not  involve  the  transfer  of 
intrinsically  valuable  commodities  produced  at  great 
cost.  The  function  of  the  bank  is  to  promote  the  use  of 
this  inexpensive  substitute  for  standard  money — credit. 
It  does  so  by  affording  a  market  wherein  credits  can  be 
bought  and  sold.  A  typical  illustration  of  this  im- 

248 


DEPOSIT  CURRENCY  249 

portant  service  to  the  business  of  the  community  is  as 
follows : 

288.  How  credit  promotes  industry. — The  process  of 
producing  from  the  raw  material  a  cotton  garment  be- 
fore it  reaches  the  consumer  requires  months  of  time 
and   the   participation   of   many   separate   industries. 
The  raw  cotton  must  be  grown  from  the  seed,  ginned, 
baled,  transported,  carded,  spun,  woven  into  cloth,  cut 
and  sewed  into  the  form  of  the  garment,  transported, 
and  sold  to  the  jobber,  then  to  the  wholesaler,  to  the 
retailer,  and  finally  to  the  consumer.     Practically  every 
step  involves  an  exchange  in  which  a  quid  pro  quo  is 
necessary.     For  example,  a  cotton-mill  owner  cannot 
perform  his  part  in  the  chain  of  production  unless  he 
can  possess  himself  of  the  raw  cotton  and  hold  it  long 
enough  to  make  it  into  cloth.     If  he  has  no  equivalent 
to  exchange  for  the  cotton,  he  is  estopped  from  business. 
The  owner  of  the  raw  cotton,  perhaps,  cannot  wait 
sixty  or  ninety  days  for  his  pay  and  he  cannot,  therefore, 
accept  the  credit  of  the  mill-owner  in  exchange  unless  he 
can  sell  that  credit  for  cash.     The  credit  of  the  mill- 
owner,  in  the  form  of  a  promissory  note,  is  not  a 
medium  of  exchange  which  the  cotton  dealer  can  use  to 
pay  his  obligations.     The  bank,  however,  stands  ready 
to  buy  that  note  and  give  for  it  something  which  can  be 
used  as  a  means  of  payment.     The  bank,  a  market  for 
negotiable  commercial  paper,  has  made  possible  the  ex- 
change of  cotton,  and  the  industry  of  the  country  has 
been  aided.     Because  a  market  for  credit  exists,  ex- 
changes can  take  place  which  would  otherwise  be  im- 
possible. 

289.  Banks    create    credits. — Besides    furnishing    a 
market  for  credits  already  in  existence,  banks  engage 
in  transactions  in  which  credits  are  created  by  receiving 


250  MONEY  AND  BANKING 

deposits  and  making  loans.  In  exchange  for  cash  de- 
posited, the  depositor  receives  the  promise  of  the  bank 
to  repay  the  sum  on  demand.  This  is  evidenced  by 
an  entry  in  the  pass  book  of  the  depositor.  The  bank 
redeems  its  promise,  either  partially  or  entirely,  when- 
ever it  accepts  a  check  drawn  upon  it  by  the  depositor. 

In  loaning  money,  the  bank  may  exchange  cash  for 
the  promise  to  pay  of  the  borrower,  either  on  demand 
(a  call-loan)  or  at  some  stated  future  time  (a  time- 
loan)  .  This,  however,  is  not  the  usual  transaction. 

Ordinarily,  when  the  bank  makes  a  loan  it  is  to  a 
regular  customer  who  has  an  account.  In  this  case  the 
borrowing  customer  receives,  in  return  for  his  promise 
to  pay,  a  credit  on  his  deposit  account  against  which 
he  may  draw  checks.  In  this  transaction  the  bank  ex- 
exchanges  its  own  promise  to  pay  money  on  demand  for 
the  promise  of  the  borrower  to  pay  a  larger  sum  at  some 
future  time  or,  if  it  is  a  call-loan,  on  demand;  the  whole 
matter  is  simply  an  exchange  of  credits.  It  is  because 
the  borrower  rarely  takes  cash  from  the  bank  but  prefers 
to  accept  a  deposit  credit,  that  the  loan  and  deposit 
items  of  the  bank  statement  correspond  so  closely  in 
amount.  Most  of  the  deposits  of  a  bank  are  created  in 
this  way;  the  rest  are  created  by  the  deposit  of  cash  or 
cash  items. 

The  deposit  item  of  a  bank  is  not,  therefore,  a  record 
of  the  sums  of  money  brought  into  the  bank  by  cus- 
tomers, although  it  includes  such  sums;  it  represents, 
rather,  the  demand  liabilities  of  the  bank  (excepting 
its  circulating  notes  outstanding) — that  is,  the  sums 
it  may  be  called  upon  to  pay  at  any  time. 

Is  it  not  clear,  therefore,  that  what  a  bank  loans  is 
not  cash  but  its  own  credit?  It  is  a  simple  matter  of 
fact  that  the  borrower  does  not  take  money  when  he 


DEPOSIT  CURRENCY  251 

gets  a  loan  but  takes  instead  a  credit  on  the  books  against 
which  he  can  draw  checks,  that  is,  he  accepts  the  promise 
of  the  bank  to  pay  on  demand,  which  is  a  deposit  credit. 
The  very  fact  that  a  deposit  credit  is  payable  on  demand 
does  not  make  it  any  the  less  a  credit. 

290.  Bank  credit  preferable  to  cash. — Why  do  per- 
sons borrow  from  the  bank  unless  they  need  the  money? 
Why  are  they  willing  to  pay  interest  on  funds  which 
they  leave  in  the  bank?    Why  are  they  willing  to  take 
the  credit  of  the  bank  instead  of  cash?    Answers  to 
these  questions  involve  a  study  of  the  business  habits 
of  the  business  community. 

A  business  man  borrows  from  a  bank  in  order  to  get 
something  with  which  to  make  payments;  not  usually 
immediate  payments,  but  payments  falling  due  from 
time  to  time  within  a  month  or  more.  The  most  con- 
venient method  of  making  payments  is  by  means  of  a 
check  drawn  against  a  deposit  credit  at  the  bank.  The 
chances  are,  however,  that  it  will  be  some  time,  perhaps 
several  weeks,  before  the  business  man  who  made  the 
loan  at  the  bank  will  have  given  out  checks  for  the  whole 
amount  of  the  loan  and  in  the  meantime  he  may  be 
receiving  funds  which  are  deposited  in  the  bank. 
Furthermore,  before  the  loan  falls  due,  he  begins  to 
accumulate  a  deposit  so  that  when  the  loan  matures  he 
has  simply  to  draw  a  check  in  favor  of  the  bank  in  order 
to  cancel  the  debt.  The  bank  has  had  the  use  of  the 
funds,  for  which  the  customer  has  been  paying  it  in- 
terest, for  some  days  after  the  loan  was  made  and  for 
some  days  before  it  is  repaid. 

291.  Shifting  of  bank  credit  without  liquidation. — 
But  there  is  still  a  further  advantage  to  the  bank.     In 
the  first  place,  the  checks  given  out  by  the  depositor 
are  not  presented  at  once  for  payment  but  may  go  to  a 


MONEY  AND  BANKING 

distant  city  and  pass  through  many  hands  before  they 
find  their  way  to  the  bank.  During  all  this  time,  per- 
haps for  a  week  or  two,  the  bank  has  the  use  of  the 
funds.  Even  when  the  check  comes  back  to  the  bank, 
the  bank  does  not  ordinarily  have  to  part  with  the  funds 
represented  by  the  check,  although  the  drawer  has 
ordered  the  bank  to  pay  to  the  presenter  the  amount. 
If  the  check  falls  into  the  hands  of  a  customer  of  the 
bank,  he  will  take  it  to  the  bank  and  increase  his  de- 
posit account  instead  of  asking  for  cash.  As  a  rule 
the  check  will  come  into  the  possession  of  a  person  who 
is  the  customer  of  another  bank  and  he  will  increase 
the  deposits  of  that  bank.  This  bank  will  present  the 
check  to  the  bank,  which  is  liable  for  its  payment,  for 
payment  through  the  clearing  house. 

Yet  even  now  the  debtor  bank  need  not  part  with  the 
cash,  for  on  the  preceding  day  it  has  received  on  deposit 
from  its  own  customers  checks  on  the  bank  holding  the 
check  against  it.  They  simply  cancel  off  their  mutual 
obligations,  perhaps  paying  a  small  balance  the  one  to 
the  other.  Still  the  money  remains  in  the  bank.  In 
fact,  the  only  time  the  bank  is  called  upon  to  redeem 
its  demand  obligations  is  when  a  check  is  actually  pre- 
sented at  the  teller's  window  for  cash  payment  or  when 
the  balances  at  the  clearing  house  are  running  against  it. 

The  bank  statement  in  the  following  chapter  shows 
that  demand  liabilities  (deposits)  of  the  banks  are  usu- 
ally four  times  as  large  as  their  cash  on  hand.  Expe- 
rience has  taught  them  that  a  cash  reserve  is  amply 
sufficient  to  meet  all  demands  for  cash  payments  which 
are  likely  to  appear.  Three-fourths  of  their  demand 
liabilities  represent  the  bank's  own  credit  which  it  is 
able  to  keep  outstanding  because  the  business  community 
prefers  to  use  checks  rather  than  cash  as  a  medium  of 


DEPOSIT  CURRENCY  253 

exchange.  This  credit  of  the  bank  serves  all  the  pur- 
poses of  money  and  the  bank  can  get  interest  for  the 
use  of  it  just  the  same  as  if  it  were  cash. 

292.  Similarity  of  checks  and  bank  notes. — It  is  pre- 
cisely the  same  as  if  the  bank  loaned  its  credit  in  the 
shape  of  bank  notes.     Before  the  Civil  War,  when  there 
was  no  restriction  on  the  issuing  power  of  banks,  the 
borrower  received  from  the  bank  its  notes,  that  is,  its 
promises  to  pay  on  demand ;  to-day  the  borrower  receives 
the  promise  of  the  bank  to  pay,  but  in  the  shape  of  a 
deposit  credit  which  really  amounts  to  exactly  the  same 
thing.     Checks,  based  on  these  deposit  credits,  circulate 
as  a  medium  of  exchange,  although  in  a  more  restricted 
way  than  the  old  bank  notes.     Nobody  will  deny  that 
a  bank  note  is  simply  the  promissory  note  of  the  bank 
and  that  the  bank  loaned  its  credit  when  it  gave  bank 
notes  to  borrowers.     Why  should  anybody  deny  that 
a  modern  bank  loans  its  credit  when  it  gives  to  the  bor- 
rower a  deposit  credit? 

293.  Limits  of  earning  power  of  the  bank. — The  main 
source  of  the  bank's  profit  is  the  interest  received  on 
loans  and  discounts,  and  it  follows  that  the  profit  varies 
directly  with  the  amount  of  loans  made.     What  then 
is  the  limit  to  the  amount  of  loans  a  bank  can  make? 
The  National  Bank  Act  sets  no  direct  limit  except  that 
it  forbids  any  national  bank  to  loan  to  any  individual 
or  firm  an  amount  greater  than  one-tenth  of  the  bank's 
capital.     Indirectly,  it  places  a  limit  on  loans  by  pro- 
viding that  national  banks  shall  keep  a  reserve  which 
shall  not  fall  below  a  certain  percentage  of  the  net  de- 
posits.    When  a  bank  gives  a  loan  it  must  either  part 
with  that  amount  of  cash,  thus  reducing  its  reserve,  or 
it  must  give  a  deposit  credit,  thus  increasing  its  net 
deposits ;  in  either  case  it  has  increased  the  ratio  between 


254.  MONEY  AND  BANKING 

reserve  and  net  deposits,  and  the  limit  to  which  this 
ratio  may  be  increased  is  one  to  four,  which  is  the  same 
as  saying  that  the  reserves  must  be  25  per  cent  of  the 
deposits. 

294.  Difference  between  a  cash  and  credit  loan. — 
When  the  bank  loans  actual  cash  instead  of  credit,  it 
increases  the  ratio  between  reserve  and  deposits  four 
times  as  much  as  when  credit  is  loaned.     For  example: 
A  bank  with  deposits  of  $1,000,000  and  a  reserve  of 
$300,000  (the  ratio  between  them  being  1:3  1-3),  loans 
$100,000.     If  the  borrower  takes  the  cash  from  the  bank, 
the  deposits  remain  as  before  but  the  reserve  has  fallen 
from  $300,000  to  $200,000,  thus  changing  the  ratio  of 
reserve  to  deposits  to  1 :5,  which  means  that  the  reserve 
is  only  20  per  cent  of  the  deposits,  and  this  is  below 
the  legal  minimum  if  the  bank  is  a  New  York  national 
bank.     Suppose,  on  the  other  hand,  that  the  borrower 
accepts  a  deposit  credit  instead  of  demanding  cash. 
The  deposits  have  increased  to  $1,100,000,  while  the 
reserve  remains  as  before  at  $300,000,  the  ratio  in  this 
case  rising  to  1:3  2-3.     When  the  borrower  took  cash, 
the  ratio  changed  from  1:3  1-3  to  1:5;  when  the  bor- 
rower took  credit,  the  ratio  changed  from  1:3  1-3  to 
1:3  2-3.     In  the  first  case,  the  reserve  was  depleted 
below  the  legal  limit;  in  the  second  case,  the  bank  could 
still  loan  another  $100,000  before  it  reached  the  limit. 
There  can  be  no  question  as  to  whether  the  bank  would 
prefer  to  loan  its  cash  or  its  credit. 

295.  Cash  a  precious  commodity  at  times. — It  be- 
comes easier  now  to  see  the  reason  why  cash  is  such  a 
precious  commodity  in  Wall  Street;  not  because  cash  is 
a  medium  of  exchange,  for  Wall  Street  uses  very  little 
of  it  in  transacting  its  business,  but  because  cash  is 
the  basis  of  credit  which  is  the  medium  of  exchange, 


DEPOSIT  CURRENCY  255 

Hence  the  rivalry  among  the  banks  to  secure  cash  de- 
posits, for  cash  deposits  mean  larger  reserves,  larger 
reserves  mean  new  credit  created  to  three  times  that 
amount,  new  credit  means  larger  loans  and  consequently 
increased  dividends.  Hence,  also,  the  great  disturbance 
caused  by  the  withdrawal  of  a  few  millions  of  cash 
deposits,  such  as  when  withdrawn  by  the  country  banks 
to  "move  the  crops."  Withdrawals  of  cash  mean  de- 
pleted reserves,  which  condition  creates  a  shrinkage  of 
bank  credit  and  a  reduction  of  profit-making  loans. 

More  than  that,  the  contraction  of  credit — the  me- 
dium of  exchange  in  99  per  cent  of  the  important 
transactions  of  the  market — has  the  same  effect  as  the 
retirement  of  a  large  portion  of  the  circulating  medium. 
The  effect  of  the  movement  of  a  few  million  dollars 
westward  to  move  the  crops  would  be  an  unimportant 
matter  if  it  involved  the  contraction  to  that  amount 
simply  of  the  medium  of  exchange;  under  present  con- 
ditions it  involves  a  contraction  of  three  times  or  more 
of  the  amount. 

Those  great  accumulators  of  cash,  the  country  banks, 
the  savings  banks,  trust  companies,  investment  com- 
panies, and  insurance  companies,  have  in  their  power 
the  control  of  the  money  market,  for  the  cash  at  their 
disposal  forms  the  basis  of  a  vast  structure  of  credit 
on  which  the  business  of  the  financial  center  of  the 
country  rests.  The  dangerous  element  in  the  situation 
arises  from  the  instability  of  this  foundation,  for  the 
withdrawal  of  cash  from  the  reserves  of  the  banks  causes 
the  collapse  of  the  superstructure,  credit. 

In  view  of  these  facts  the  rate  of  interest  which  the 
New  York  banks  pay  for  cash  deposits,  1%  per  cent 
or  2  per  cent,  is  a  small  matter.  For  every  dollar  of 
cash  deposited  they  are  enabled  to  loan  credit  to  three 


256  MONEY  AND  BANKING 

times  the  amount  at  from  2  per  cent  to  6  per  cent,  thus 
making  a  gross  profit  of  from  5  per  cent  to  15  per  cent 
on  the  deposit. 

The  word  "deposit"  is  ambiguous  and  has  a  dual 
nature.  When  a  banker  asserts  that  he  makes  5  per 
cent  gross  profit  on  his  deposits,  he  uses  the  term  as 
meaning  demand  liabilities  outstanding  (excepting,  of 
course,  circulating  notes) .  A  deposit  of  cash  in  a  bank, 
however,  means  something  more  than  an  increase  of  that 
amount  of  the  demand  liabilities  of  the  bank;  it  means 
an  increase  of  reserve  to  that  amount,  on  the  basis  of 
which  the  bank  is  justified  in  increasing  its  demand  lia- 
bilities by  three  times  the  amount  deposited,  and  this  it 
usually  does  if  there  is  a  market  for  the  loans.  On 
the  receipt  of  a  deposit  of  $1000  cash,  the  bank  does 
not  put  $250  in  the  reserve  and  loan  $750;  it  puts  $1000 
in  the  reserve  (for  the  reserve  is  not  a  special  fund,  but 
represents  practically  all  the  cash  on  hand  at  any  par- 
ticular time)  and  increases  its  loans  and  demand  lia- 
bilities (deposits)  $3000,  if  it  is  a  national  bank,  or  more 
if  it  is  not. 

296.  Problem  of  the  reserve  of  greatest  importance. — 
The  problem  of  what  constitutes  a  sufficient  reserve  is 
one  that  engages  the  mind  of  bankers  at  all  times.  The 
amount  of  credit  which  they  can  keep  afloat  and  upon 
which  their  profits  depend  is  determined  by  the  size  of 
the  reserve  which  they  can  hold  in  their  vaults.  It  is 
obvious  that  if  a  large  proportion  of  the  demand  credits 
are  presented  at  any  one  time  that  the  bank  cannot  meet 
them.  This  happens  only  when  some  event  occurs  that 
shakes  the  confidence  which  the  depositors  have  in  the 
bank.  If  the  bank  cannot  dispose  of  its  assets  by  bor- 
rowing from  the  other  banks,  it  must  fail.  In  addition 
to  this  danger  there  are  certain  times  of  year,  varying 


DEPOSIT  CURRENCY  257 

in  different  localities,  when  banks  increase  their  reserves. 
It  may  be  that  more  actual  money  is  used  in  hand  to 
hand  transfers,  or  that  the  banks  expect  a  demand  for 
local  loans  that  causes  them  to  increase  their  reserves. 
When  there  is  any  general  movement  on  the  part  of  the 
country  banks  toward  increasing  their  reserves,  such  as 
takes  place  every  year  when  the  crops  start  to  move,  the 
withdrawal  of  actual  money  from  the  reserve  cities 
causes  bank  reserves  there  to  fall  in  volume.  Con- 
versely, when  the  demand  for  money  in  the  interior 
subsides,  the  money  flows  back  into  the  reserve  city 
banks,  and  their  reserves  are  thus  increased.  Hence 
a  reserve  which  is  sufficient  at  one  time  of  year  may  not 
be  at  another;  and  reserves  which  are  sufficient  during 
a  period  when  the  granting  of  credit  is  on  a  normal 
basis  may  be  lamentably  insufficient  when  there  is  a 
general  demand  for  liquidation. 

297.  Lack  of  cooperation  causes  banks  to  lose  re- 
serves.— Unfortunately,  under  our  present  system,  there 
is  very  little  cooperation  between  the  banks  of  different 
cities  when  demand  for  liquidation  becomes  general. 
Each  bank  does  everything  in  its  power  at  such  times 
to  increase  its  reserve,  and  it  must  all  be  at  the  expense 
of  some  other  bank.     The  writer  knows  personally  of 
several  banks  which  increased  their  reserve  during  the 
recent  panic  until  they  totaled  75  per  cent  of  their 
deposits. 

298.  Methods  of  increasing  reserves. — At  such  times 
there  are  only  two  ways  of  increasing  the  total  of  the 
country's  bank  reserves  until  they  begin  to  be  increased 
automatically  by  the  gradual  liquidation  of  credit.     The 
most  common  method  is  to  negotiate  for  gold  abroad. 
This  is  slow,  however,  and  is  apt  to  be  expensive.     The 
second  method  is  by  the  deposit  of  Government  funds 

VII— 17 


258  MONEY  AND  BANKING 

with  the  hanks.  This  was  of  great  assistance  during  the 
panic  of  1907,  but  it  could  be  taken  advantage  of  by 
the  holders  of  certain  securities  which  the  Government 
offered  to  accept  as  collateral  for  the  loan.  Since  that 
experience  the  law  has  been  changed  so  that  the  list 
of  acceptable  securities  has  been  greatly  enlarged;  and 
thre  is  no  doubt  but  that  the  new  arrangement  would 
prove  of  value  if  the  experience  should  be  repeated. 
This  presupposes,  however,  an  available  surplus  of 
money  in  the  United  States  Treasury,  on  the  presence 
of  which  it  is  not  safe  to  rely. 

299.  Secondary  reserve. — A  great  many  banks,  in  ad- 
dition to  their  cash  reserve,  carry  what  is  sometimes 
known  as  a  secondary  reserve.  The  cash  reserve  means 
money  on  hand  and  deposited  in  other  banks.  The 
secondary  reserve  consists  of  any  securities  which  are 
readily  marketable.  Railroad  and  such  municipal  bonds 
as  are  listed  on  the  New  York  Stock  Exchange  are  the 
most  popular,  because  they  are  bought  and  sold  daily, 
and  the  banker  may  always  ascertain  their  market  value 
by  recourse  to  the  daily  paper.  There  are  certain  issues 
which  are  very  active  on  the  exchange,  hence  they  best 
serve  the  bankers'  purpose.  Because  of  this,  many  bank- 
ers fall  into  the  error  of  thinking  that  any  bond  which 
is  listed  is  readily  marketable.  There  are  a  great  many 
issues,  however,  which  are  listed  but  for  which  it  may 
be  far  from  easy  to  find  a  market.  It  may  be  that 
the  issue  is  small  and  not  widely  known;  or  it  may  be 
that  the  bonds  are  closely  held  by  a  few  interests.  In 
either  case  the  issue  is  not  active,  and  the  bonds  will  not 
always  sell  readily. 

The  great  fallacy  of  the  theory  of  investment  in 
listed  bonds  on  the  assumption  that  they  are  salable, 
however,  is  more  fundamental.  Even  when  a  bank  se- 


DEPOSIT  CURRENCY  259 

lects  as  a  secondary  reserve,  bonds  which  are  active,  it 
does  not  follow  that  they  can  be  sold  when  there  is  a 
general  demand  for  liquidation.  The  same  issue  of 
bonds  may  be  held  by  a  thousand  banks  over  the  country 
on  the  same  theory  and  it  is  needless  to  say  that  they 
cannot  all  convert  them  at  the  same  time.  If  any  of 
them  sell,  it  will  be  at  a  great  sacrifice  in  price,  and 
with  each  sale  the  price  declines  still  further. 

300.  Unreliability  of  bonds  as  reserves. — It  must  not 
be  supposed  from  this  that  investment  in  listed  bonds 
is  unwise.     In  practice  they  have  many  times  proved 
to  be  a  very  valuable  asset,  but  generally  for  a  somewhat 
different  reason.     First,  they  are  readily  marketable 
except  during  panics,  so  that  if  a  bank  wishes  to  realize 
on  its  bonds  for  reasons  peculiar  to  itself  it  may  do  so 
without  great  loss.     Furthermore,  in  the  panic  of  1907 
the  city  banks  refused  to  redeem  any  credits  in  cash, 
so  that  even  if  bonds  had  been  sold  on  the  exchange, 
the  sale  would  not  have  obtained  for  them  any  currency. 
This  action,  however,  enabled  them  to  make  more  loans 
than  they  otherwise  could  have  made,  and  the  bonds  of 
their  country  correspondents  were  very  acceptable  col- 
lateral.    When  the  country  banks  saw  the  market  price 
of  bonds  falling  off",  they  preferred  borrowing  with 
their  bonds  as  collateral  to  selling,  especially  as  neither 
alternative  netted  them  any  actual  currency. 

301.  Aldrich-Vreeland  act. — Most  important  of  all  in 
making  bonds  a  valuable  asset  in  a  panic  is  the  Aldrich- 
Vreeland  act,  passed  by  Congress  in  1908,  which  recog- 
nizes the  security  of  certain  bonds  by  making  them 
acceptable  as  collateral  to  secure  deposits  of  money  from 
the  Government.     Prior  to  the  passage  of  this  act,  Gov- 
ernment bonds  only  could  be  used  to  secure  Government 
deposits,  and  Government  bonds  are  an  expensive  asset. 


CHAPTER  XVII 

BANK  STATEMENT— RESOURCES 

302.  Combined  statement. — In  passing  from  the  the- 
oretical to  the  practical  discussion  of  banking,  it  is  well 
for  the  student  to  become  familiar  with  the  bank  state- 
ment. It  is  a  summing  up  of  all  the  transactions  of  the 
bank — a  condensed  record  of  all  the  books  of  account — 
and  every  transaction,  no  matter  how  small,  produces  a 
change  in  the  statement.  An  understanding,  therefore, 
of  all  the  items  of  the  bank  statement  will  provide  a 
good  introduction  to  the  actual  practice  of  the  business. 

The  statement  reproduced  in  section  303  on  page  261 
is  the  combined  statement  of  all  the  national  banks  in  the 
country.  The  federal  law  provides  that  each  national 
bank  shall  make  a  report  to  the  comptroller  of  the  cur- 
rency at  least  five  times  each  year.  The  dates  for  mak- 
ing the  reports  are  not  fixed  but  are  announced  by  the 
comptroller  at  intervals.  It  is  a  peculiarity  of  the  bank- 
ing business  that  it  may  have  a  complete  report  of  its 
financial  condition  at  the  end  of  each  day.  In  a  mercan- 
tile or  manufacturing  establishment  it  is  possible  to  have 
such  a  statement  only  after  an  inventory  of  the  stock  on 
hand  is  taken.  The  assets  of  a  bank  are  of  such  a  nature 
that  the  perpetual  inventory  can  be  kept. 

It  was  thought  best  to  take  the  report  of  all  the 
national  banks  rather  than  a  statement  of  any  single 
bank;  the  items  are  exactly  the  same  and  the  relation 
between  the  different  amounts  is  more  typical  of  the 
average  bank  than  any  single  statement  could  be. 

260 


BANK  STATEMENT— RESOURCES 

303.  Proof  of  the  deposit  currency  theory. — Further- 
more, the  figures  showing  the  relation  between  loans, 
deposits  and  reserves,  are  the  best  proof  that  can  be 
offered  as  to  the  validity  of  the  deposit-currency  theory 
presented  in  the  preceding  chapter.  It  will  be  observed 
that  the  total  volume  of  loans  and  discounts  in  the  6544 
national  banks  in  1907  was  but  little  over  four  and  a 
half  billion  of  dollars.  The  individual  deposits,  or  the 
amount  due  to  depositors  of  all  sorts  except  banks,  was 
a  little  less  than  four  and  a  half  billion  dollars.  The 
amount  of  reserve,  including  the  specie  and  legal  tender 
notes  and  5  per  cent  redemption  fund,  amounted  to 
something  over  one  billion  dollars,  or  20.8  per  cent  of 
the  deposit  liability.  Since  the  total  amount  of  money 
of  all  descriptions  in  this  country  is  only  a  h'ttle  more 
than  three  billion  dollars,  and  since  the  deposits  in  the 
state  banks  and  trust  companies,  combined  with  the 
figures  given,  will  make  a  total  of  over  twelve  billion 
dollars,  it  requires  no  argument  to  show  that  the  item 
"deposits"  does  not  represent  cash  deposited  but  rather 
credit  extended  by  the  bank.  There  is  not  enough 
actual  cash  in  the  whole  world  to  pay  the  depositors  of 
the  banks  of  the  United  States  if  they  should  suddenly 
desire  to  exercise  their  legal  right  and  all  at  once  call 
for  payment  of  their  deposits. 

COMBINED  REPORTS  REQUIRED  BY  THE  COMPTROLLER  OF 
THE  CURRENCY  FROM  THE  NATIONAL  BANKS.i 

BANK  STATEMENT. 

6,544  BANKS  AUG.  22,  1907. 
RESOURCES: 

1.  Loans  and  discounts  on  which  officers  and  directors  are 

liable,  either  as  payers  or  indorsers. 
Loans  and  discounts  on  which  officers  and  directors  are 

not  liable  as  payers  or  indorsers $4,678,583,968.99 

2.  Overdrafts,  secured,  $ ,  unsecured,  $ 30,443,119.51 

3.  U.  S.  Bonds  to  secure  circulation,  par  value 557,277,950.00 

4.  U.  S.  Bonds  to  secure  U.  S.  deposits,  par  value 95,628,650.00 

i  Report  of  Comptroller  of  Currency,  1907,  p.  9. 


262  MONEY  AND  BANKING 

5.  Other  bonds  to  secure  U.  S.  deposits 68,198,039.03 

6.  U.  S.  bonds  on  hand 7,390,840.00 

7.  Premium  on  bonds  for  circulation;  premium  on  other  U. 

S.  bonds 14,554,194.17 

8.  Bonds,  securities,  etc.,  including  premium  on  same 700,352,456.58 

9.  Banking  house;  furniture  and  fixtures 160,845,896.15 

10.  Other  real  estate  owned 20,241,913.97 

11.  Due  from  National  Banks  (not  approved  reserve  agents)  334,571,435.56 

12.  Due  from  State  and  private  banks  and  bankers,  trust 

companies  and  savings  banks 123,020,454.14 

13.  Due  from  approved  reserve  agents 614,496,352.27 

\4.  Checks  and  other  cash  items 26,905,246.13 

15.  Exchanges  for  the  clearing  house 190,602,163.58 

16.  Bills  of  other  national  banks 31,240,127.00 

17.  Fractional  paper  currency,  nickels  and  cents 2,314,530.17 

18.  Lawful  money  reserve  in  bank,  specie,  legal  tender  notes.  701,623,532.52 

19.  Redemption  fund  with  the  U.  S.  Treasurer 27,305,679.43 

20.  Due  from  the  U.  S.  Treasurer 4,731,853.60 


$8,390,328,402.80 

LIABILITIES: 

21.  Capital  stock  paid  in $  896,451,314.00 

22.  Surplus    fund 548,303,602.00 

23.  Undivided  profits,  including  amounts  set  aside  for  spe- 

cial purposes.     Less  current  expenses  and  taxes  paid  186,554,1*1.85 

24.  Circulating  notes  secured  by  U.  S.  bonds.    Less  amount 

on  hand  in  Treasury  for  redemption  or  in  transit. . .  551,949,461.50 

25.  State  bank  circulation  outstanding 30,419.50 

26.  Due  to  National  Banks  (not  approved  reserve  agents)  . .  823,680,087.29 

27.  Due  to  state  and  private  banks  and  bankers 395,745,494.77 

28.  Due  to  trust  companies  and  savings  banks 337,927,872.50 

29.  Due  to  approved  reserve  agents 38,139,918.96 

30.  Dividends  unpaid 1,583,606.56 

31.  Individual  deposits  subject  to  checks. 

32.  Demand  certificates  of  deposit. 


33.  Time  certificates  of  deposit. 


4,319,035,402.62 


34.  Certified  checks. 

35.  Cashier's  check  outstanding. 

36.  U.  S.  deposits ." 143,282,393.15 

37.  Deposits  of  U.  S.  disbursing  officers 17,755,770.92 

38.  Bonds  borrowed 59,994,634.56 

39.  Notes  and  bills  rediscounted 14,415,550.30 

40.  Bills    payable 44,760,529.68 

41.  Reserved  for  taxes 4,358,763.69 

42.  Other  liabilities 6,859,429.01 


$8,390,328,402.80 

304.  Double-entry  system. — The  first  thing  to  be 
noted  about  the  statement  on  this  page  is  that  the  two 
columns  of  resources  and  liabilities  exactly  balance  each 
other  to  the  cent.  The  reason  of  this  is  to  be  found  in 
the  system  of  double-entry  bookkeeping  by  which  every 
transaction  is  recorded  twice,  so  that  it  is  impossible  to 


BANK  STATEMENT— RESOURCES  263 

alter  the  credit  or  resource  side  without  at  the  same  time 
changing  the  liability  or  debit  side.  Under  this  system 
the  bank  is  considered  as  having  no  property  of  its  own, 
but  that  all  its  resources  above  its  liabilities  belong  to 
the  stockholders,  and  these  resources  are  classified  as 
part  of  the  liabilities  under  the  items  capital  stock,  sur- 
plus funds,  dividends,  profits,  and  dividends  unpaid. 
These  items  are  liabilities  of  the  bank  only  in  the  event 
of  liquidation. 

The  fact  that  the  resources  and  liabilities  of  the  bank 
are  equal  has  no  bearing  whatever  on  its  solvency.  The 
last  statement  given  out  before  a  bank  fails  invariably 
shows  the  resources  to  be  equal  to  the  liabilities.  The 
discrepancy  must  be  looked  for  in  some  of  the  items: 
either  the  resources  have  been  put  in  at  valuations  above 
their  real  worth,  or  some  item  of  liability  has  been 
omitted  or  reduced.  It  is  almost  always  discovered  in 
the  event  of  a  failure  that  loans  and  discounts  contain 
items  which  are  far  less  than  the  figures  set  down. 
Under  resources  are  put  down  all  the  items  of  property 
owned  by  the  bank  and  all  sums  due  to  be  paid  to  it 
in  the  future.  Under  liabilities  are  placed  all  the  debts 
owing  by  the  bank  and  all  items  representing  the  equity 
of  the  stockholders  in  the  property  of  the  bank.  In 
other  words,  the  liability  side  of  the  statement  simply 
indicates  to  whom  the  resources  belong  in  case  the  bus- 
iness of  the  bank  were  to  be  settled  up  instantly. 

305.  Alterations  in  value  of  resources. — The  items  on 
the  resource  side  may  increase  or  diminish  without  any 
transactions  having  taken  place  and  therefore  without 
any  changes  having  been  made  in  the  liability  side. 
Some  of  the  loans  may  prove  to  be  bad  and  non-col- 
lectible, or  some  of  the  real  estate  or  bonds  may  increase 
in  market  value;  profits  may  be  made  or  losses  may  be 


264  MONEY  AND  BANKING 

incurred.  It  is  impossible  constantly  to  adjust  the 
values  given  in  the  statement  to  correspond  to  the  real 
conditions.  In  some  banks  the  adjustment  is  made 
periodically;  in  others  only  when  it  is  discovered  that 
the  alteration  of  value  is  permanent;  and  in  still  others 
it  is  never  made. 

306.  Concealed  assets. — It  frequently  happens  that 
where  the  items  of  property  have  enhanced  in  value  the 
figures  on  the  statement  are  allowed  to  remain  absurdly 
low,  creating  what  is  called  "concealed  assets."     It  is 
considered  by  a  great  many  bankers  an  evidence  of 
conservatism  to  continue  to  list  at  a  low  figure,  property 
worth  much  more  than  its  book  value.     There  can  be  no 
objection  to  this  practice  so  long  as  everybody  under- 
stands the  real  condition  and  knows  that  the  statement 
is  a  fictitious  one.     The  objection  to  the  practice  comes 
from  the  fact  that  even  the  stockholders  do  not  realize 
the  full  value  of  their  stock  and  may  be  induced  to  part 
with  it  at  a  price  which  they  would  not  consider  at  all 
if  they  knew  the  equity  represented  by  it. 

We  will  now  take  up  each  item  separately  with  such 
explanations  as  are  necessary  to  describe  the  transac- 
tions by  which  it  is  created. 

307.  Loans  and  discounts. — This  item  of  assets  is  in 
the  form  of  promissory  notes  of  individuals  or  corpora- 
tions.    The  discount  represents  notes  which  have  been 
purchased  or  discounted  by  the  bank  at  a  certain  price 
below  their  face  value  at  maturity.     The  difference  be- 
tween the  value  at  maturity  and  the  price  paid  is  called 
discount,  and  is  at  once  credited  to  the  profit  account, 
appearing  under  "liabilities"  in  the  item  "undivided 
profits."     "Loans,"  technically  speaking,  represents  the 
sum  paid  out  equal  to  the  face  of  the  note ;  at  maturity 
the  bank  will  receive  that  amount  plus  the  interest.    The 


BANK  STATEMENT— RESOURCES  265 

difference  between  loans  and  discounts,  therefore,  is  that 
in  the  case  of  loans  the  hank  does  not  realize  its  profit 
until  the  note  is  due;  in  the  case  of  discounts  the  hank 
takes  its  profit  when  the  transaction  is  made. 

Discounting  has  always  been  considered  the  peculiar 
business  of  a  bank.  In  Pennsylvania  the  trust  com- 
panies are  not  empowered  to  discount,  but  they  have  the 
right  to  loan  money  and  to  purchase  notes  and  other 
obligations.  The  prohibition  of  discount  does  not  pre- 
vent the  trust  companies  from  doing  a  general  banking 
business;  instead  of  discounting  they  simply  purchase 
the  notes  outright  or  loan  the  funds  on  the  security 
of  the  notes,  taking  the  interest  at  maturity. 

On  the  back  of  the  bank  report  are  printed  certain 
schedules  which  must  be  filled  out  in  order  to  show  more 
in  detail  the  meaning  of  the  various  items.  The  law 
provides  that  "all  debts  due  to  an  association,  on  which 
interest  is  past  due,  and  unpaid,  for  the  period  of  six 
months,  unless  the  same  are  well  secured,  and  in  process 
of  collection,  shall  be  considered  bad  debts  within  the 
meaning  of  this  section." 

All  such  notes  must  be  listed  in  the  schedule,  together 
with  all  notes  which  are  overdue  and  all  notes  repre- 
senting liability  of  directors  as  borrowers.  While  there 
is  no  law  limiting  the  right  of  the  bank  to  loan  to  its 
directors  on  the  same  terms  as  to  any  other  person,  it  is 
recognized  that  the  privilege  is  likely  to  be  abused  and 
hence  the  banks  are  asked  to  make  a  separate  statement 
of  such  loans. 

308.  Overdrafts. — Where  banking  is  not  conducted 
on  the  strictest  business  principles  the  depositors  are 
likely  to  overdraw  their  accounts.  Under  certain  local 
conditions  of  business  overdrafts  are  unavoidable.  But 
the  good  banker  can  usually  arrange  with  the  depositor 


266  MONEY  AND  BANKING 

to  give  a  note  to  the  bank  for  the  amount  and  thus  con- 
vert the  overdraft  into  a  loan  or  discount.  If  a  certain 
maximum  temporary  credit  is  wanted  to  draw  against, 
a  demand  note  should  be  given  to  the  bank,  the  amount 
passed  to  the  customer's  credit,  and  when  settlement  is 
made  the  customer  should  be  charged  with  the  interest 
on  the  amount  checked  out. 

309.  United  States  bonds  to  secure  circulation. — This 
item  represents  bonds  owned  by  the  bank  but  deposited 
in  Washington.     The  law  requires  the  bank  to  deposit 
or  to  own  United  States  bonds  up  to  25  per  cent  of 
its  capital  whether  circulation  is  taken  out  on  them  or 
not.     The  value  of  the  bonds  is  given  at  par  and  not 
at  market  value. 

310.  United  States  bonds  to  secure  United  States 
deposits. — The  law  provides  that  the  funds  of  the  United 
States  not  required  by  the  Treasury  may  be  deposited 
in  national  banks  if  United  States  bonds,  or  under  cer- 
tain circumstances  other  bonds  approved  by  the  secre- 
tary of  the  treasury,  are  deposited  in  Washington  as 
collateral.     The  secretary  may  use  his  discretion  as  to 
whether  other  than  Government  bonds  shall  be  accepted 
at  all  and  what  bonds  may  be  accepted  as  collateral 
security. 

311.  United  States  bonds  on  hand. — Sometimes  the 
banks  hold  Government  bonds  in  their  own  vaults  with- 
out using  them  to  secure  circulation.     It  is  not  likely 
that  any  bank  would  hold  Government  bonds  as  an  in- 
vestment, and  it  is  likely  that  this  item  represents  bonds 
which  it  is  expected  will  be  sold  to  customers  of  the  bank 
or  will  be  required  later  for  securing  circulation. 

312.  Premiums  on  United  States  bonds. — This  item 
represents  the  difference  between  the  par  value  and 


BANK  STATEMENT— RESOURCES  267 

market  value  of  the  United  States  bonds  owned  by  the 
bank. 

313.  Bonds,  securities,  etc. — This  item  embraces  be- 
sides   bonds,    also    stocks,    chattel-mortgages,    judg- 
ments, claims,  etc.,  owned  by  the  bank.     The  securities 
which  are  deposited  by  borrowers  as  collateral  security 
for  loans  do  not  appear  in  the  statement  because  they 
are  not  the  property  of  the  bank  until  default  has  been 
made  on  the  note.     Under  the  law  national  banks  are 
not  allowed  to  own  corporation  stocks  unless  it  is  neces- 
sary to  take  them  in  the  collection  of  a  debt.     This  item, 
therefore,  represents  practically  the  bonds  owned  by  the 
banks.     It  has  increased  greatly  within  the  past  few 
years,  because  many  of  the  banks  are  dealers  in  bonds 
and  hold  them  pending  their  sale  to  customers,  and  fur- 
thermore because  the  ready  market  which  is  at  hand  un- 
der normal  conditions  for  the  bonds  causes  the  bank  to 
regard  them  as  a  form  of  secondary  reserve  which  can 
almost  immediately  be  converted  into  money  in  case  of 
emergency. 

314.  Banking  house  furniture  and  fixtures. — The 
comptroller  has  been  rather  strict  in  interpreting  the 
law  with  reference  to  the  holdings  of  real  estate  by 
banks.     The  large  office  buildings  which   have   been 
erected  to  house  the  banks  as  well  as  to  accommodate 
hundreds  of  tenants  have  been  erected  by  separate  com- 
panies, usually  composed  of  the  same  stockholders  as 
the  bank. 

315.  Other  real  estate  holdings. — This  item  includes 
not  only  real  estate  but  all  mortgages  and  assets  rep- 
resenting real  estate.     The  law  is  very  strict  in  limiting 
the  power  of  the  bank  to  hold  real  estate,  as  indicated 
in  the  following  provision: 


268  MONEY  AND  BANKING 

A  national  banking  association  may  purchase,  hold,  and  convey 
real  estate  for  the  following  purposes,  and  for  no  others : 

First.  Such  as  shall  be  necessary  for  its  immediate  accommoda- 
tion in  the  transaction  of  its  business. 

Second.  Such  as  shall  be  mortgaged  to  it  in  good  faith  by  way 
of  security  for  debts  previously  contracted. 

Third.  Such  as  shall  be  conveyed  to  it  in  satisfaction  of  debts 
previously  contracted  in  the  course  of  its  dealings. 

Fourth.  Such  as  it  shall  purchase  at  sales  under  judgments, 
decrees,  or  mortgages  held  by  the  association,  or  shall  purchase 
to  secure  debts  due  to  it. 

But  no  such  association  shall  hold  the  possession  of  any  real 
estate  under  mortgage,  or  the  title  and  possession  of  any  real 
estate  purchased  to  secure  any  debts  due  to  it,  for  a  longer  period 
than  five  years. 

The  object  of  this  provision  is  to  prevent  the  banks 
from  investing  their  resources  in  forms  which  are  not 
readily  convertible  into  current  funds.  In  former 
years,  before  there  was  so  much  property  other  than  real 
estate  which  could  be  used  as  security  for  loans,  the 
banks  were  almost  forced  to  take  mortgages  or  nothing 
at  all.  In  times  of  stringency  when  depositors  were  de- 
manding cash,  the  banks  were  frequently  embarrassed 
and  forced  into  insolvency  because  they  could  not  con- 
vert real  estate,  which  under  such  circumstances  is 
always  very  unsalable  except  at  a  tremendous  sacrifice, 
into  funds  which  would  satisfy  their  depositors. 

316.  Due  from  national  banks. — This  represents  de- 
posits in  other  national  banks  which  may  not  be  counted 
as  part  of  the  reserve. 

317.  Due  from  approved  reserve  agents. — Under  the 
law  the  country  national  banks  may  deposit  in  the  re- 
serve cities,  three-fifths  of  the  15  per  cent  of  their  de- 


BANK  STATEMENT— RESOURCES  269 

posits  required  as  reserve.  In  the  reserve  cities  national 
banks  may  deposit  one-half  of  the  25  per  cent  required 
in  central  reserve  cities. 

318.  Checks  and  other  cash  items — exchanges  for 
the  clearing  house. — Under  these  headings  are  included 
everything  which  may  be  immediately  convertible  into 
cash.     In  cities  where  there  is  a  clearing  house  the 
checks  on  the  clearing  house  banks  are  listed  separately. 

In  the  statement  we  see  that  the  exchanges  for  the 
clearing  house  are  over  seven  times  as  great  as  the 
checks  and  other  cash  items.  This  shows  the  propor- 
tion of  checks,  etc.,  which  can  be  collected  inexpensively 
and  also  the  proportion  which  must  be  collected  by 
mail. 

319.  Bills  of  other  national  banks. — The  national 
banks  are  not  allowed  to  count  other  national  bank  notes 
as  part  of  their  reserve.     It  is  therefore  to  their  interest 
to  have  as  few  of  them  on  hand  as  possible.     To  ac- 
complish this  they  pay  them  out  before  any  other  form 
of  currency,  or  send  them  to  Washington  to  replenish 
the  5  per  cent  redemption  fund  or  to  make  other  pay- 
ments to  the  Treasury. 

Under  the  different  items  representing  specie  it  will 
be  noted  that  the  gold  and  silver  certificates  are  in- 
cluded. 

320.  Legal  tender  notes. — This  represents  the  green- 
backs held  by  the  banks  and  also  the  Treasury  notes  of 
1890,  which  are  now  very  rare. 

321.  Redemption  fund. — Every  national  bank  is  re- 
quired to  keep  on  deposit  with  the  Treasury  of  the 
United  States  a  fund  equal  to  5  per  cent  of  its  outstand- 
ing circulation.     This  requirement  is  no  hardship  at  all 
to  the  bank  because  it  can  count  this  amount  as  part  of 


270  MONEY  AND  BANKING 

its  reserve.  It  makes  no  difference  whether  the  money 
is  in  its  own  vaults  or  in  the  vaults  of  the  Treasury  at 
Washington. 

322.  Due  from  the  United  States  Treasury. — This 
item  includes  any  amounts  due  from  the  Treasury  other 
than  the  5  per  cent  fund,  such  as  notes  of  other  national 
banks,  or  forms  of  currency,  or  bonds  forwarded  to  it 
for  redemption. 


CHAPTER  XVIII 

BANK  STATEMENT— LIABILITIES 

323.  Capital  stock  paid  in. — The  capital  stock  of  a 
bank  represents  the  funds  paid  in  by  the  stockholders. 
The  National  Bank  Act  provides  that  no  bank  shall 
begin  to  do  business  until  50  per  cent  of  the  capital  has 
been  paid  in  cash,  and  the  balance  must  be  paid  in 
installments  of  at  least  10  per  cent  per  month. 

The  capital  is  the  margin  paid  up  by  the  stockholders 
to  protect  the  creditors  in  case  of  any  shrinkage  in 
the  resources.  The  law  requires  no  stated  percentage 
of  capital  proportionate  to  the  size  of  the  bank,  but 
aims  to  prevent  under-capitalization  by  the  following 
section: 

Sec.  5138  as  amended  by  act  of  March  14,  1900).  No  as- 
sociation shall  be  organized  with  a  less  capital  than  $100,000, 
except  that  banks  with  a  capital  of  not  less  than  $50,000  may, 
with  the  sanction  of  the  Secretary  of  the  Treasury  be  organized 
in  any  place  the  population  of  which  does  not  exceed  three  thou- 
sand inhabitants.  No  association  shall  be  organized  in  a  citj 
the  population  of  which  exceeds  fifty  thousand  persons  with  a 
capital  of  less  than  $200,000.* 

By  this  requirement  of  a  certain  maximum  capital 
for  banks  in  towns  of  more  than  a  certain  population 
the  act  prohibits  the  establishment  of  banks  with  insuf- 
ficient capital  in  cities  where  the  loans  and  deposits  are 
likely  to  be  large.  Until  1900  the  minimum  capital  for 

i  National  Bank  Act,  p.  7. 

271 


272  MONEY  AND  BANKING 

a  national  bank  was  $50,000 ;  since  that  time  it  has  been 
$25,000  to  encourage  the  establishment  of  national 
banks  in  small  towns  where  hitherto  the  amount  of  busi- 
ness was  too  small  to  justify  the  organization  of  a  bank 
with  larger  capitalization. 

Sec.  5139.  The  capital  stock  of  each  association  shall  be  di- 
vided into  shares  of  $100  each,  and  be  deemed  personal  prop- 
erty, and  transferable  on  the  books  of  the  association  in  such 
manner  as  may  be  prescribed  in  the  by-laws  or  articles  of  asso- 
ciation. Every  person  becoming  a  shareholder  by  such  transfer 
shall,  in  proportion  to  his  shares,  succeed  to  all  the  rights  and  lia- 
bilities of  the  prior  holder  of  such  shares.1 

324.  Double  liability  of  stockholders. — The  shares  of 
stock  in  a  bank  differ  from  stock  in  other  corporations 
in  the  double  liability  feature.  The  principle  of  limited 
liability  is  an  almost  universal  feature  of  corporation 
laws  in  this  country  and  the  stockholders  cannot  be  made 
liable  for  further  payments  for  the  stock  if  it  has  been 
fully  paid.  The  idea  of  limited  liability  is  of  course  to 
make  it  possible  for  persons  who  are  unwilling  to  take 
unlimited  risk  in  becoming  partners  in  an  enterprise  to 
become  stockholders  with  a  maximum  risk  of  losing 
only  what  they  have  paid  in.  In  the  case  of  banks, 
however,  it  has  become  a  fixed  custom  not  only  in  the 
national  bank  act  but  also  in  most  of  the  state  statutes 
to  place  a  double  liability  on  the  shareholders  for  the 
better  protection  of  depositors;  the  reason  being  that 
the  depositors  are  creditors  of  an  entirely  different  sort 
from  the  creditors  of  other  corporations. 

Sec.  5151.  The  shareholders  of  every  national  banking  asso- 
ciation shall  be  held  individually  responsible  equally  and  ratably, 
and  not  for  one  another,  for  all  contracts,  debts,  and  engage- 

i  National  Bank  Act. 


BANK  STATEMENT— LIABILITIES  273 

ments  of  such  association  to  the  extent  of  the  amount  of  their 
stock  therein,  at  the  par  value  thereof,  in  addition  to  the  amount 
invested  in  such  shares,  except  that  shareholders  of  any  banking 
association  now  existing  under  state  laws  having  not  less  than 
$5,000,000  of  capital  actually  paid  in  and  a  surplus  of  20 
per  centum  on  hand,  both  to  be  determined  by  the  Comptroller 
of  the  Currency,  shall  be  liable  only  to  the  amount  invested  in 
their  shares ;  and  such  surplus  of  20  per  centum  shall  be  kept  un- 
diminished,  and  be  in  addition  to  the  surplus  provided  for  in  this 
title;  and  if  at  any  time  there  is  a  deficiency  in  such  surplus  of 
20  per  centum  such  association  shall  not  pay  any  dividends  to 
its  shareholders  until  the  deficiency  is  made  good;  and  in  case 
of  such  deficiency  the  Comptroller  of  the  Currency  may  compel 
the  association  to  close  its  business  and  wind  up  its  affairs  under 
the  provisions  of  chapter  four  of  this  title.1 

The  whole  purpose  of  requiring  a  certain  capital  sum 
to  be  contributed  by  the  shareholders  can  be  defeated 
by  the  subsequent  withdrawal  of  its  funds  as  loans  to 
shareholders.  It  has  frequently  happened  that  banks 
have  been  started  with  capital  borrowed  by  the  incor- 
porators,  which  borrowings  have  been  repaid  just  as 
soon  as  the  bank  was  in  position  to  make  loans  to  the 
shareholders. 

In  the  statement  it  will  be  noticed  that  the  capital 
stock  of  all  the  national  banks  amounts  to  a  little  less 
than  one  billion  dollars,  or  a  little  more  than  one-fifth 
of  the  deposits.  This  means  that  there  must  be  a 
shrinkage  of  20  per  cent  in  the  assets  of  the  banks  be- 
fore the  depositors  are  in  any  danger. 

325.  Surplus  fund. — This  item  signifies  that  a  cer- 
tain portion  of  the  resources  in  addition  to  the  capital 
paid  in  belongs  to  the  stockholders.  The  surplus  is 
created  either  by  cash  paid  in  at  the  organization  of 

i  National  Bank  Act. 
VII— 18 


274  MONEY  AND  BANKING 

the  bank  in  addition  to  the  capital  paid,  for  which  no 
stock  is  issued,  or  it  represents  profits  which  have 
accumulated  and  which  have  not  been  paid  out  in  divi- 
dends. 

The  idea  of  the  surplus  fund  is  to  provide  an  item 
in  the  liabilities  which  can  be  used  to  represent  changes 
in  the  equity  of  the  stockholders  in  the  reserves  without 
altering  the  capital  stock.  If  the  bank  should  suffer 
a  loss  of  resources  in  any  manner  beyond  the  amount 
of  undivided  profits,  the  capital  of  the  bank  would  be 
impaired  if  it  were  not  for  the  surplus. 

A  surplus  is  required  by  law  under  the  following 
section: 

Sec.  5199.  The  directors  of  any  association  may  semi-ammally 
declare  a  dividend  of  so  much  of  the  net  profits  of  the  associa- 
tion as  they  shall  judge  expedient ;  but  each  association  shall,  be- 
fore the  declaration  of  a  dividend,  carry  one-tenth  part  of  its  net 
profits  of  the  preceding  half  year  to  its  surplus  fund  until  the 
same  shall  amount  to  20  per  centum  of  its  capital  stock.1 

A  liberal  surplus  enhances  the  credit  of  the  bank 
and  for  that  reason  new  banks  frequently  start  with  a 
surplus  of  50  or  100  per  cent  of  the  capital  subscribed. 
This  proves  an  advantage  in  several  ways.  The  banks 
are  required  to  purchase  fewer  bonds  than  they  would 
if  the  whole  investment  had  been  put  into  the  capital. 
In  states  where  the  shares  of  the  bank  are  taxed  on 
their  par  value  it  reduces  the  personal  property  tax  of 
the  holders  thereof. 

On  the  other  hand  the  smaller  amount  of  capitaliza- 
tion reduces  the  power  of  the  bank  to  issue  circulating 
notes  and  until  the  recent  amendment  to  the  law  for- 
bidding the  banks  to  loan  more  than  10  per  cent  of  their 

i  National  Bank  Act,  p  28. 


BANK  STATEMENT— LIABILITIES  275 

capital  and  surplus  the  banks  were  restricted  to  10  per 
cent  of  their  capital  alone. 

The  fact  that  the  shares  of  stock  represent  the  equity 
of  the  holders  not  only  in  the  capital  but  also  in  the 
surplus  gives  the  par  value  of  bank  stock  much  less 
meaning  than  the  "book  value."  The  book  value  of 
the  bank  stock  represents  the  $100  par  value  plus  the 
proportionate  share  of  the  surplus. 

326.  Undivided  profits. — Unlike  the  majority  of 
manufacturing  businesses  the  profits  of  a  bank  are  car- 
ried to  the  profit  and  loss  account  as  they  accrue  each 
day.  From  the  gross  profits  must  be  deducted  all  the 
expenses  of  doing  the  business.  At  the  end  of  the  fiscal 
year  the  directors  meet  and  declare  dividends  from  this 
item,  the  effect  of  which  is  to  transfer  a  part  of  it  to 
the  account  of  dividends  unpaid  and  the  balance  to  the 
surplus.  Sometimes  the  dividends  when  payable  are 
placed  directly  to  the  accounts  of  the  shareholders  when 
they  happen  to  be  depositors  as  well. 

327. — National  bank  notes  outstanding. — This  item 
represents  the  amount  of  notes  for  which  the  bank  is 
still  liable.  All  the  notes  which  the  comptroller  has 
forwarded  to  the  bank  are  charged  against  it  until  he 
has  received  the  notes  back  again  or  in  their  place  has 
received  lawful  money  for  their  redemption.  If  the 
bank  has  any  of  these  notes  on  hand  they  will  be  de- 
ducted from  this  account. 

It  will  be  noted  that  the  amount  of  national  bank 
notes  outstanding  almost  equals  the  amount  of  United 
States  bonds  deposited  in  the  Treasury  to  secure  circu- 
lation. At  the  particular  time  this  report  was  made 
the  banks  were  putting  out  as  much  circulation  as  pos- 
sible on  their  bond  deposits  on  account  of  the  very  high 
rate  of  interest  at  which  they  could  loan  the  funds. 


276  MONEY  AND  BANKING 

The  amount  of  bonds  to  secure  circulation  is  consid- 
erably over  one-half  the  capital  stock  of  the  combined 
banks,  showing  that  the  banks  are  disposed  to  hold  more 
bonds  than  they  are  required  to  under  the  law. 

328.  State  bank  notes  outstanding. — This  small  item, 
which  amounts  to  only  $30,000,  is  a  vestige  of  the  Civil 
War  period.     Many  of  the  state  banks  of  that  time  were 
converted  into  national  banks.     The  circulation  which 
they  had  outstanding  at  that  time  could  not  be  called  in 
and  $30,000  of  it  has  never  been  presented  for  redemp- 
tion. 

The  items  due  other  national  banks,  state  banks,  trust 
companies,  and  approved  reserve  agents  represent  the 
deposits  made  by  other  banks. 

329.  Individual  deposits. — This  item  represents  the 
amount    due    to    individuals    and    corporations.     The 
amount  signifies  the  obligations  of  the  bank  which  may 
be  demanded  at  any  time  during  banking  hours.     This 
obligation  is  created  either  by  the  deposit  of  money  or 
cash  items  which  appear  in  the  opposite  column  under 
these  headings,  or  by  the  loans  which  the  bank  has 
granted  to  customers,   and   corresponds   to  the   item 
"Loans  and  Discounts"  on  the  resource  side.     The  pe- 
culiar nature  of  this  item  was  explained  in  the  preceding 
chapter. 

On  the  books  of  the  bank  the  individual  deposits 
appear  under  several  accounts.  By  far  the  largest 
amount  is  recorded  in  the  individual  ledgers  and  is  sub- 
ject to  check.  For  some  of  the  deposits  the  banks  have 
issued  certificates  of  deposit  either  payable  on  demand 
or  at  a  certain  date.  These  deposits  are  not  subject 
to  check  and  are  usually  payable  only  upon  the  return 
of  the  certificate  which  is  negotiable.  These  deposits 
closely  resemble  savings  deposits  except  that  they  rep* 


BANK  STATEMENT— LIABILITIES  277 

resent  a  deposit  made  at  one  time  instead  of  in  install- 
ments. The  certificate  of  the  bank  is  sometimes  given 
by  the  bank  instead  of  a  note,  where  funds  have  been 
borrowed. 

330.  United  States  deposits  and  deposits  of  United 
States  disbursing  officers. — The  Government  deposits 
secured  by  bonds  are  divided  into  two  classes.     The  first 
is  more  permanent  in  character  and  consists  of  funds 
owned  by  the  Government  in  excess  of  the  disburse- 
ments  required.     The   second   class   signifies   deposits 
which  have  been  made  by  officers  of  the  Government 
temporarily  but  which  will  soon  be  required  to  make 
payments  to  Government  creditors. 

331.  Bonds  borrowed. — There  is  no  requirement  in 
the  National  Bank  Act  that  the  bonds  deposited  by  the 
banks  to  secure  circulation  or  deposits  shall  be  owned 
outright  by  the  bank.     Some  banks  find  it  profitable 
to  borrow  from  investors  or  other  financial  institutions 
the  bonds  required  for  the  purposes  mentioned.     So 
long  as  the  borrowing  bank  is  solvent  and  the  interest 
on  the  bonds  is  paid  regularly  to  the  real  owners,  the 
latter  suffer  no  disadvantage  whatever  from  having  the 
bonds  out  of  their  possession. 

332.  Notes  and  bills  rediscounted. — This  item,  so  in- 
significant in  amount,  suggests  the  great  difference 
between  American  and  European  banking.     In  this 
country  it  is  considered  a  confession  of  financial  weak- 
ness if  a  bank  seeks  to  rediscount  any  of  the  paper 
held  by  it.     In  Europe,  on  the  contrary,  a  large  pro- 
portion of  the  paper  purchased  or  discounted  by  the 
bank  is  acquired  with  the  expectation  of  rediscounting 
it.     This  is  a  great  advantage  because  it  places  any 
bank  in  a  position  of  being  able  to  loan  to  any  amount, 
knowing  that  it  can  always  replace  the  funds  by  redis- 


278  MONEY  AND  BANKING 

counting  the  notes.  In  the  United  States,  however, 
when  any  bank  has  reached  the  limit  of  its  loaning 
power,  it  is  obliged  to  refuse  accommodation  to  its  cus- 
tomers, no  matter  how  pressing  their  need  or  how  dis- 
tressing the  consequences  of  denying  them  the  funds. 
The  practice  of  rediscounting  practically  amounts  to 
making  available  for  the  whole  community  the  credit 
of  the  local  bank  in  the  larger  money  markets.  The 
failure  of  American  bankers  to  adopt  the  practice  of 
rediscounting  with  all  its  advantages  both  to  themselves 
and  the  community,  particularly  to  the  community,  is 
much  more  inexplicable  because  the  disadvantages  of  the 
system  appear  to  be  insignificant  compared  to  its  ad- 
vantages. 

333.  Bills  payable. — This  item,  which  is  more  than 
three  times  as  large  as  the  preceding  one,  signifies  that 
the  banks  have  borrowed  outright  the  sum  represented 
instead  of  selling  some  of  their  resources. 

334.  Certified    check. — This   is    an   ordinary   check 
drawn  by  a  depositor  which  has  been  certified  by  the 
cashier  or  other  appropriate  officer  and  which  has  not 
yet  been  presented  for  payment.     When  the  bank  certi- 
fies a  check  the  amount  is  taken  from  the  account  of  the 
depositor  and  placed  in  the  certified  check  account.     By 
this  act  it  becomes  a  direct  obligation  of  the  bank  the 
same  as  a  promissory  note.     If  the  bank  should  fail 
before  it  is  presented  for  payment  the  holder  would  have 
no  recourse  upon  the  original  drawer  of  the  check.     The 
fact  that  the  holder  chose  to  have  it  certified  instead 
of  demanding  payment  at  the  bank  throws  the  risk  of 
non-payment  upon  him.     If  the  maker  of  the  check 
himself  had  it  certified  his  liability  for  payment  is  the 
same  as  in  the  case  of  an  ordinary  check. 

335.  Cashier's  checks  outstanding. — This  item  repre- 


BANK  STATEMENT— LIABILITIES  279 

sents  the  checks  which  the  cashier  has  signed  on  behalf 
of  the  bank  against  deposits  in  other  banks  or  checks 
upon  the  bank  itself.  New  York  exchange  is  the  name 
given  to  cashier's  checks  which  are  payable  at  New 
York  banks  and  which  are  sold  by  banks  throughout  the 
country  to  persons  wishing  to  make  remittances. 


CHAPTER  XIX 

ORGANIZATION  AND  BUSINESS  OF  THE  BANK 

336.  National  banks. — Five  different  kinds  of  insti- 
tutions in  this  country  are  included  in  the  general  term 
bank:     National  banks,  state  banks,  trust  companies, 
private  banks,  and  savings  banks. 

National  banks  are  corporations  which  are  char- 
tered by  the  Federal  Government  to  assist  the  United 
States  Treasury  in  providing  the  paper  currency 
of  the  country.  The  strict  limitations  imposed  upon 
these  banks  by  law,  especially  the  law  which  prohibits 
them  from  loaning  on  real  estate  security,  is  offset  by 
the  credit  which  their  national  charter  and  supervision 
by  the  examiners  gives  them  in  the  community. 

337.  State  banks. — State  banks  are  chartered  by  the 
several  states.     The  legal  restrictions  thrown  around 
them  vary  widely  but  in  general  the  state  statutes  are 
modeled  after  the  National  Bank  Act.     The  differences 
between  national  banks  and  state  banks  so  far  as  the 
functions  they  perform  are  concerned,  are  so  unimpor- 
tant that  it  is  not  worth  while  to  discuss  them  separately ; 
therefore  what  follows  will  refer  primarily  to  national 
banks.     Since  the  Civil  War  state  banks  have  been  al- 
lowed to  issue  paper  currency  only  upon  payment  of  a 
10  per  cent  per  annum  tax,  which  is  so  high  as  to  be  abso- 
lutely prohibitive  and  in  consequence  the  state  banks 
issue  no  paper  currency. 

338.  Private  banks. — Private  banks  are  partnerships 
in  which  each  of  the  partners  is  liable  for  all  the  debts 

280 


ORGANIZATION  AND  BUSINESS  281 

of  the  firm  to  the  extent  of  his  private  fortune.  The 
only  private  banks  of  any  considerable  size  are  those 
dealing  in  foreign  exchange,  in  bonds,  or  in  real  estate. 
An  important  function  of  private  bankers  is  the  pro- 
motion of  new  corporations  and  underwriting  for  new 
issues  of  securities.  The  firm  of  J.  P.  Morgan  and 
Company  is  typical  of  this  class. 

339.  Underwriting. — When  a  new  issue  of  securities 
is  to  be  brought  out  an  arrangement  is  usually  made 
with  professional  financiers  who  understand  how  to 
make  a  market  for  them.  As  the  officers  of  the  cor- 
poration issuing  them  are  usually  not  qualified  to  mar- 
ket a  very  large  issue  a  specialist  in  that  line  is  in 
demand.  The  underwriter  agrees  to  sell  the  entire  issue 
at  a  certain  fixed  price ;  sometimes  he  gets  a  commission 
but  more  often  he  relies  for  his  profit  on  selling  the 
securities  above  the  agreed  price.  If  an  issue  is  larger 
than  his  own  firm  can  handle  he  may  organize  a  syndi- 
cate, with  himself  as  syndicate  manager.  He  then 
invites  other  capitalists  or  firms  to  subscribe  to  the  syndi- 
cate. If  the  market  conditions  are  good  the  whole  issue 
can  be  disposed  of  without  calling  upon  the  subscribers 
to  furnish  any  funds.  It  is  usual  in  the  case  of  the 
subscribers  that  they  know  nothing  about  the  whole 
transaction  from  the  time  of  their  agreement  to  provide 
a  certain  sum  if  necessary  until  they  receive  a  check 
representing  their  share  of  the  profits.  If  the  issue 
should  fail  to  find  a  market  it  may  be  necessary  to  call 
upon  the  subscribers  to  make  up  the  loss,  or  at  least 
to  give  them  the  privilege  of  taking  up  their  share  of 
the  unsold  securities  at  the  syndicate  price.  The  very 
large  proportion  of  "undigested  securities"  which  so 
troubled  the  financial  world  in  1903  and  caused  the  rich 
man's  panic  of  that  year,  were  securities  which  under- 


writing  syndicates  had  failed  to  sell  to  the  public  and 
had  to  carry  themselves  on  margin  at  their  bankers. 

340.  Trust  companies. — A  trust  company  was  origi- 
nally not  a  bank  at  all  but  a  company  incorporated  to 
execute  trusts  in  the  legal  sense.     The  large  powers 
granted  to  these  corporations  were,  sometimes  "inad- 
vertently," found  to  include  the  powers  necessary  to  do 
a  banking  business  without  many  of  the  limitations  of 
state  banks.     In  the  last  twenty  years  there  has  been 
an  enormous  growth  of  this  type  of  institution,  and  it 
has  become  a  very  serious  competitor  of  both  national 
and  state  banks. 

341.  Banking  department. — The  trust  company  has 
two  distinct  departments,  the  bank  department  and  the 
trust  department,  with  two  sets  of  officers.     The  bank- 
ing department  is  conducted  almost  the  same  as  a  com- 
mercial bank,  although  the  conditions  and  laws  in  the 
different  localities  have  forced  it  to  take  on  a  different 
form  to  suit  the  circumstances.     In  New  York  City, 
for  example,  the  trust  companies  have  specialized  largely 
in  the  collateral  loan  business. 

Until  recently  the  trust  companies  in  New  York  City 
were  not  required  to  keep  any  reserve.  Instead  of 
placing  money  in  their  own  vaults,  therefore,  they  either 
deposited  in  national  banks,  receiving  thereon  a  small 
rate  of  interest,  or  loaned  it  for  stock  exchange  purposes 
at  call  loan  rates.  These  loans  could  be  converted  into 
cash  at  such  short  notice  under  ordinary  circumstances 
that  the  trust  companies  felt  it  unnecessary  to  keep  any 
other  reserve.  When  the  volume  of  this  business 
reached  enormous  proportions  the  national  and  state 
banks  felt  that  they  were  forced  to  have  on  hand  ready 
money  sufficient  to  provide  for  any  sudden  demands, 
not  only  at  their  own  counters  but  at  the  counters  of 


ORGANIZATION  AND  BUSINESS  283 

aD  the  trust  companies  as  well.  They  feared  that  in 
time  of  general  panic  the  small  percentage  of  cash  rela- 
tive to  the  demand  deposits  of  both  banks  and  trust 
companies  would  precipitate  a  disaster.  At  this  time 
the  trust  companies  were  members  of  the  clearing  house 
and  in  order  to  force  the  trust  companies  to  keep  re- 
serves they  passed  a  rule  requiring  all  members  to  keep 
in  cash  25  per  cent  of  their  deposits.  The  trust  com- 
panies were  unwilling  to  comply  with  this  provision  and 
withdrew  from  the  clearing  house,  nor  have  they  ever 
returned  to  it,  preferring  to  make  their  collections  on 
city  checks  in  the  more  cumbersome  manner.  Recently 
the  state  of  New  York  has  passed  a  law  requiring  the 
trust  companies  to  keep  a  reserve  of  15  per  cent. 

342.  Deposits  of  trust  companies. — In  a  great  many 
localities  the  trust  company  has  developed  an  entirely 
new  field  hitherto  neglected  by  the  banks.     By  adver- 
tising and  other  means  they  have  attracted  large  num- 
bers of  personal  accounts  of  people  who  had  never 
before  thought  of  having  a  bank  account.     These  de- 
positors are  given  the  privilege  of  drawing  an  unlimited 
number  of  checks  against  their  account  and  are  usually 
paid  interest  on  their  daily  balances  of  2  per  cent. 
While  these  personal  accounts  do  not  average  very 
large,  still  they  are  so  numerous  that  the  total  is  con- 
siderable.    However,  most  of  them  are  fairly  inactive, 
and  the  number  of  checks  required  to  be  handled  is  not 
excessive.     With  the  improved  methods  of  bookkeep- 
ing and  the  use  of  adding  machines,  etc.,  the  trust  com- 
panies have  found  that  it  is  profitable  to  cater  to  this 
class  of  customers. 

343.  Trust  department. — The  trust  department  of 
the  trust  company  has  no  banking  function  whatever, 
and  the  great  number  of  trust  companies  do  not  pretend 


284  MONEY  AND  BANKING 

to  do  this  sort  of  business  at  all.  The  importance  of 
this  business,  however,  in  modern  finance  warrants  a 
brief  description. 

344.  Individual  trusts. — A  trust  department  of  any 
size  will  be  divided  into  two  parts,  an  individual  and 
a  corporate  trust  department,  each  in  charge  of  a  trust 
officer.     The  function  of  the  individual  trust  depart- 
ment is  to  act  as  trustee  for  the  property  of  individuals, 
as  guardian  for  minors  and  incompetents,  as  conservator 
of  estates,  as  executor  of  wills  and  administrator  of  the 
estates  of  intestates.    A  great  deal  of  this  business 
comes  to  the  trust   company  by   appointment  of  the 
courts.     The  duties  of  the  trust  company  require  it  to 
manage  large  amounts  of  property  in  the  form  of  real 
estate  and  securities.     Hence  it  is  necessary  for  them 
to  have  a  real  estate  and  bond  department.     The  bond 
department  of  many  trust  companies  has  grown  beyond 
the  requirements  of  trusteeship  into  a  regular  bond 
house  for  the  general  purchase  and  sale  of  securities. 

345.  Corporate   trusts. — The   corporate   department 
acts  as  trustee  under  corporate  mortgages  and  trust 
deeds.     When  a  corporation  wishes  to  issue  bonds  under 
a  single  mortgage  it  is  impossible  for  each  one  of  the 
shareholders  to  have  a  separate  mortgage.     The  trust 
company  holds  the  mortgage  subject  to  the  terms  pre- 
scribed in  the  bond,  and  in  case  of  default  of  principal 
or  interest  on  the  bond  it  proceeds  against  the  corpora- 
tion in  the  interests  of  all  the  bond  holders.     It  also 
acts  as  fiscal  agent  for  corporations,  taking  charge  of 
the  payments  of  coupons  when  they  are  due  and  receiv- 
ing and  holding  sinking  funds  to  provide  for  the  retire- 
ment of  the  obligations  at  maturity.     When  an  issue 
of  bonds  is  subject  to  redemption  the  trust  company 
may  take  charge  of  the  drawing  of  the  numbers  and 


ORGANIZATION  AND  BUSINESS  285 

the  payment  of  the  call  bonds.  The  trust  company 
may  act  as  registrar  for  corporations,  authenticating 
the  issues  of  stocks  and  bonds  in  order  to  prevent  an 
over-issue.  It  frequently  acts  as  transfer  agent  for 
corporations  if  it  is  located  in  a  central  city.  In  the 
case  of  failures  a  trust  company  sometimes  acts  as  re- 
ceiver under  the  direction  of  the  court.  All  these  func- 
tions are  of  modern  development  but  so  necessary  have 
they  become  that  it  would  be  almost  impossible  to  dis- 
pense with  them. 

346.  Savings  banks. — A  savings  bank  is  really  not  a 
bank  at  all,  if  the  word  is  restricted  in  its  use  to  institu- 
tions which  provide  a  medium  of  exchange.  A  savings 
bank  is  more  closely  related  to  the  investment  company. 
Its  purpose  is  simply  to  receive  funds  in  small  amounts 
for  investment  in  securities  or  real  estate.  The  deposits 
are  not  subject  to  check  and  the  bank  may  even  require 
thirty  days'  notice  before  making  payment.  Conse- 
quently the  savings  bank  is  under  no  necessity  for  keep- 
ing a  reserve.  On  the  other  hand,  the  savings  bank 
has  no  credit  which  it  can  loan  and  receive  an  income 
upon.  The  business  of  the  savings  bank  is  simplicity 
itself.  It  simply  gathers  together  small  sums  which 
of  themselves  are  too  small  for  investment  and  pur- 
chases with  them  interest-yielding  securities  or  mort- 
gages. They  usually  pay  interest  of  3  per  cent  or  more 
to  depositors,  while  the  income  from  the  investments  is 
usually  below  5  per  cent.  In  some  states,  like  Massa- 
chusetts and  New  York,  where  the  laws  restrict  very 
closely  the  securities  in  which  the  savings  may  be  in- 
vested, thus  forcing  the  savings  bank  to  buy  only  first 
class  securities,  the  margin  is  frequently  less  than  1  per 
cent.  The  expenses  of  the  business,  however,  are  so 
small  that  even  a  1  per  cent  margin  is  profitable.. 


286  MONEY  AND  BANKING 

347.  The  organization  of  a  bank. — The  usual  method 
of  organizing  a  bank  is  first  to  get  a  subscription  of 
the  necessary  capital.     Recently  companies  have  been 
formed  for  the  purpose  of  opening  new  banks  in  com- 
munities where  the  recent  growth  of  business  has  justi- 
fied their  establishment.     These  companies,  when  they 
have  found  a  locality  which  promises  to  develop  suffi- 
cient business  to  be  profitable,  provide  the  capital  and 
the  oificers.     When  the  bank  is  once  started  and  the 
people  of  the  community  interested  as  depositors  and 
patrons,  then  the  organizing  company  sells  the  stock  to 
local  capitalists  and  employs  the  capital  in  establishing 
new  banks  elsewhere. 

348.  Evolution   of   the   bank. — In   communities   of 
slower  growth,  however,  the  bank  is  usually  an  evolu- 
tion.    First  the  local  merchant  or  wealthy  farmer  with 
idle  capital  makes  loans  to  his  neighbors  and  friends. 
As  the  original  capital  grows  the  merchant  or  farmer 
may  find  that  the  loaning  business  with  all  its  details 
is  becoming  more  important  than  his  regular  occupation. 
People  have  learned  to  trust  these  men  in  their  regular 
lines  of  business  and  intrust  to  them  for  safe  keeping 
their  savings  or  valuables.     They  are  also  asked  to  take 
charge  of  estates  and  are  consulted  with  reference  to 
investments,  etc.     In  the  course  of  time  these  men  find 
it  necessary  to  have  separate  offices  arranged  for  the 
convenient  transaction  of  this  financial  business  and  per- 
haps to  have  assistance  in  their  bookkeeping.     This  may 
gradually  develop  into  the  private  bank,  or  the  size  of 
the  business  may  make  it  advisable  to  take  other  men 
into  the  business. 

349.  Stockholders. — In   an   incorporated    bank   the 
stockholders  are  the  ultimate  authority.     Their  power, 
however,  is  all  delegated  to  a  number  of  directors.     Once 


ORGANIZATION  AND  BUSINESS  287 

a  year  the  shareholders  of  the  bank  have  the  right  to 
choose  directors,  after  which  they  are  entirely  powerless, 
except  in  cases  of  fraud  on  the  part  of  the  directors, 
until  time  for  a  new  election  arrives. 

350.  Directors. — It  is  upon  the  directors  that  the 
whole  responsibility  of  the  bank  falls.  The  National 
Bank  Act  makes  certain  requirements  of  directors  which 
are  set  forth  in  the  following  sections : 

Sec.  5145.  The  affairs  of  each  association  shall  be  managed 
by  not  less  than  five  directors,  who  shall  be  elected  by  the  share- 
holders at  a  meeting  to  be  held  at  any  time  before  the  association 
is  authorized  by  the  Comptroller  of  the  Currency  to  commence 
the  business  of  banking,  and  afterward  at  meetings  to  be  held 
on  such  day  in  January  of  each  year  as  is  specified  therefor  in 
the  articles  of  association.  The  directors  shall  hold  office  for 
one  year,  and  until  their  successors  are  elected  and  have  qualified. 

Sec.  5146.  Every  director  must,  during  his  whole  term  of  serv- 
ice, be  a  citizen  of  the  United  States,  and  at  least  three-fourths 
of  the  directors  must  have  resided  in  the  state,  territory  or 
district  in  which  the  association  is  located  for  at  least  one  year 
immediately  preceding  their  election,  and  must  be  residents 
therein  during  their  continuance  in  office.  Every  director  must 
own,  in  his  own  right,  at  least  ten  shares  of  the  capital  stock  of 
the  association  of  which  he  is  a  director,  unless  the  capital  of 
the  bank  shall  not  exceed  $25,000,  in  which  case  he  must  own 
in  his  own  right  at  least  five  shares  of  such  capital  stock.  Any 
director  who  ceases  to  be  the  owner  of  the  required  number  of 
shares  of  the  stock,  or  who  becomes  in  any  other  manner  dis- 
qualified, shall  thereby  vacate  his  place. 

Sec.  5147.  Each  director,  when  appointed  or  elected,  shall 
take  an  oath  that  he  will,  so  far  as  the  duty  devolves  on  him, 
diligently  and  honestly  administer  the  affairs  of  such  association, 
and  will  not  knowingly  violate,  or  willingly  permit  to  be  vio- 
lated, any  of  the  provisions  of  this  title,  and  that  he  is  the  owner 
in  good  faith,  and  in  his  own  right,  of  the  number  of  shares  of 


288  MONEY  AND  BANKING 

stock  required  by  this  title,  subscribed  by  him,  or  standing  in 
his  name  on  the  books  of  this  association,  and  that  the  same  is 
not  hypothecated  or  in  any  way  pledged  as  security  for  any  loan 
or  debt.  Such  oath,  subscribed  by  the  director  making  it,  and 
certified  by  the  officer  before  whom  it  is  taken,  shall  be  immedi- 
ately transmitted  to  the  Comptroller  of  the  Currency,  and  shall 
be  filed  and  preserved  in  his  office. 

Sec.  5239.  And  in  cases  of  such  violation  every  director  who 
participated  in  or  assented  to  the  same  shall  be  held  liable  in 
his  personal  and  individual  capacity  for  all  damages  which  the 
association,  its  shareholders,  or  any  other  person  shall  have  sus- 
tained in  consequence  of  such  violation. 

Sec.  5239.  If  the  directors  of  any  national  banking  associa- 
tion shall  knowingly  violate,  or  knowingly  permit  any  of  the 
officers,  agents,  or  servants  of  the  association  to  violate,  any 
of  the  provisions  of  this  title,  all  the  rights,  privileges,  and 
franchises  of  the  association  shall  be  thereby  forfeited.  Such 
violation  shall,  however,  be  determined  and  adjudged  by  a  proper 
circuit,  district,  or  territorial  court  of  the  United  States,  in  a 
suit  brought  for  that  purpose  by  the  Comptroller  of  the  Cur- 
rency, in  his  own  name,  before  the  association  shall  be  declared 
dissolved. 

In  recent  years  the  responsibility  of  the  directors  of 
banks  has  become  an  important  question.  With  the 
increase  in  the  size  and  the  complexity  of  the  business 
of  a  bank  it  has  become  more  difficult  to  get  business 
men  to  serve  on  the  directory  who  are  willing  to  con- 
sent to  contribute  enough  of  their  time  to  get  fully 
and  thoroughly  familiar  with  the  business  of  the  bank. 
It  has  never  been  customary  to  pay  salaries  to  directors 
and  the  small  fee  of  $5  to  $20  per  meeting  is  not  suffi- 
cient to  justify  busy  men  in  giving  up  much  of  their 
time. 

351.  Considerations  governing  choice  of  directors. — 
The  credit  of  the  bank  and  its  attractiveness  to  depos- 


ORGANIZATION  AND  BUSINESS  289 

itors  depend  in  no  small  measure  upon  the  reputation 
of  the  men  on  the  board  of  directors,  and  hence  it  has 
become  the  custom  to  select  men  for  that  position  whose 
names  are  likely  to  prove  a  business  asset,  not  only 
among  the  business  men  of  their  particular  line  but  with 
the  general  public.  In  most  cases  these  men  are  not 
familiar  even  with  the  rudiments  of  banking  and  in 
many  cases  rarely  attend  the  meetings  of  the  board. 
Under  these  circumstances  it  has  been  comparatively 
easy  for  dishonest  officials  to  use  the  funds  of  the  bank 
in  their  own  private  interests  and  this  has  often  resulted 
in  the  ruin  of  the  bank.  In  an  address  before  the  Penn- 
sylvania Bankers'  Association  in  Philadelphia  in  1906, 
Mr.  William  B.  Ridgely,  at  that  time  Comptroller  of 
the  Currency,  made  the  following  radical  statement: 

Except  from  very  rare  and  exceptional  causes,  such  as  sudden 
panics  or  runs  due  to  false  rumors,  there  is  never  any  reason- 
able excuse  for  the  failure  of  bank  or  trust  company.  It  is 
almost  always  the  result  of  inexcusable  folly  and  incompetence 
or  dishonesty  and  fraud,  and  often  due  to  all  these  combined. 
When  a  bank  does  fail,  it  is  the  fault  of  the  board  of  directors. 
Many  others  may  be  to  blame,  perhaps  more  than  the  directors, 
but  the  final  responsibility  of  bank  management  rests  upon  the 
directors  and  they  are  to  blame. 

In  many  cases  the  federal  courts  have  declared  that 
a  director's  duty  is  not  discharged  by  merely  electing 
officers  of  good  reputation,  ability  and  integrity  to  man- 
age a  bank  and  then  leaving  its  business  in  their  hands. 
The  board  of  directors,  the  courts  have  held,  is  bound 
to  maintain  a  supervision  of  the  affairs  of  its  associa- 
tion, and  to  have  a  general  knowledge  of  the  character 
of  its  business  and  the  manner  in  which  it  is  conducted, 
and  to  know  at  least  upon  what  security  its  larger  lines 
of  credit  are  given. 

VII— 19 


290  MONEY  AND  BANKING 

352.  Briggs  v.  Spaulding. — The  United  States  Su- 
preme Court  decision  most  in  point  is  the  case  of  Briggs 
v.  Spaulding,  which  was  a  suit  brought  by  the  receiver 
of  the  First  National  Bank  of  Buffalo  against  the  de- 
fendants as  directors  for  failure  to  perform  faithfully 
and  diligently  the  duties  of  their  offices.  It  was  alleged 
that  they  had  failed  to  call  and  hold  meetings,  to  appoint 
any  committee  of  examination,  to  require  bonds,  or  to 
make  personal  examination  into  the  conduct  and  man- 
agement of  the  affairs  of  the  bank,  but  that  instead  they 
allowed  the  executive  officers  to  manage  it  without  super- 
vision. In  rendering  its  decision  the  court  said : 

Without  reviewing  the  various  decisions  on  the  subject,  we 
hold  that  directors  must  exercise  ordinary  care  and  prudence  in 
the  administration  of  the  affairs  of  the  bank,  and  that  this  in- 
cludes something  more  than  officiating  as  figureheads.  They  are 
entitled  under  the  law  to  commit  the  banking  business,  as  de- 
fined, to  their  duly  authorized  officers,  but  this  does  not  absolve 
them  from  the  duty  of  reasonable  supervision,  nor  ought  they  to 
be  permitted  to  be  shielded  from  liability  because  of  want  of 
knowledge  of  wrongdoing,  if  that  ignorance  is  the  result  of 
gross  inattention.1 

The  law  requires  more  of  directors  than  a  reasonable 
care  in  selecting  the  officers  of  the  bank.  Although 
there  has  been  great  difficulty  in  charging  the  directors 
with  civil  liability  for  ignorance  in  cases  where  banks 
have  failed,  yet  the  federal  courts  have  laid  down  cer- 
tain principles  with  which  every  director  should  be 
familiar.  Referring  to  the  case  of  Briggs  v.  Spauld- 
ing, the  court  in  another  case  said: 

In  my  opinion  it  does  not  meet  the  requirements  of  this  state- 
ment of  the  law  that  directors  may  confide  the  management  of 

l  Priggs  v.  Spaulding,  141  U.  S.  132. 


ORGANIZATION  AND  BUSINESS  291 

the  operations  of  the  bank  to  a  trusted  official,  and  then  repose 
upon  their  confidence  in  his  right  conduct  without  making  ex- 
aminations themselves,  or  relying  upon  his  answers  to  general 
questions  put  to  him  with  regard  to  the  status  of  the  affairs  of 
the  bank.  The  idea  is  not  to  be  tolerated  that  they  serve  as 
merely  gilded  ornaments  of  the  institution,  to  enhance  its  at- 
tractiveness, or  that  their  reputations  should  be  used  as  a  lure 
to  customers.  .  .  .  It  is  inconsistent  with  the  purposes  and 
policy  of  the  Banking  Act  that  its  vital  interests  should  be  com- 
mitted to  one  man,  without  oversight  and  control.2 

353.  Ignorance  no  excuse. — Directors  may  not  ex- 
cuse themselves  from  liability  on  the  plea  of  igno- 
rance.    Although   it   is    a    physical   impossibility    for 
directors  to  have  personal  knowledge  of  the  condition 
of  the  books  and  funds  of  a  very  large  bank,  yet  it  is 
possible  and  even  imperative  for  them  to  employ  public 
accountants  to  make  audits  of  the  affairs  of  the  bank 
independent  of  the  federal  or  state  examinations. 

354.  Supplementary    examinations    necessary. — The 
fact  that  the  National  Bank  Act  requires  a  frequent  ex- 
amination of  the  bank  by  regularly  appointed  examiners 
is  not  sufficient.     These  examinations  are  necessarily 
incomplete  because  of  the  limitations  placed  upon  the 
examiner.     Under  the  older  methods  of  doing  the  bank- 
ing business  no  loan  was  granted  until  the  directors  had 
specifically  authorized  it.     Applications  for  loans  were 
recorded  in  an  offering  book  which  was  placed  before 
the  board  at  every  meeting,  and  no  loans  were  granted 
until  the  formal  consent  was  given.     This  method  is  too 
slow  and  cumbersome  in  these  days  and  it  is  doubtful 
whether  any  number  of  directors  would  have  sufficient 
credit  information  to  intelligently  authorize  every  loan. 
However,  it  is  not  too  much  to  demand  of  a  board  of 

2  Gibbons  v.  Anderson,  80  Fed.  Rep.  345. 


292  MONEY  AND  BANKING 

directors  that  they  be  familiar  with  every  loan  which 
may  become  dangerous  to  the  bank.  Experience  has 
shown  that  large  losses  have  occurred  only  where  the 
directors  have  allowed  the  law  to  be  violated  by  loaning 
more  than  10  per  cent  of  the  capital  to  one  person  or 
corporation.  Furthermore,  every  loan  made  to  a  direc- 
tor or  officer  of  the  bank  should  be  carefully  considered 
in  the  board  meetings.  If  every  director  were  familiar 
with  these  two  types  of  loans  and  exercised  his  best 
judgment  in  passing  upon  them  there  would  be  few 
losses  from  these  sources.  Moreover,  it  would  be  impos- 
sible to  deceive  the  directors  regarding  such  loans  be- 
cause an  independent  auditor  instructed  to  report 
specially  upon  this  point  could  not  fail  to  discover  any 
irregularities. 

355.  Opinion  of  Comptroller  Ridgely. — On  this 
point  Mr.  Ridgely  speaks  as  follows: 

Above  all,  the  directors  of  a  bank  should  most  closely  scru- 
tinize the  loans  to  officers  and  other  directors,  and  see  that  they 
are  kept  down  to  not  only  legal  but  safe  amounts. 

Far  the  most  frequent  cause  of  bank  troubles,  in  fact,  the 
almost  invariable  cause  of  bank  failures,  is  the  granting  of 
credits  far  beyond  the  legal  and  prudent  limits  to  the  officers  or 
to  one  concern  or  group  of  allied,  concerns,  generally  owned 
and  managed  by  the  officers  or  directors  of  the  bank,  or  in  which 
they  have  directly  or  indirectly,  some  large  pecuniary  interest. 

When  a  bank  is  in  anything  approaching  this  condition,  it  is 
in  grave  danger,  for  its  entire  safety  depends  on  the  success  of 
outside  enterprises,  and  the  man  who  should  protect  the  bank 
has,  perhaps,  a  greater  interest  in  protecting  the  other  con- 
cern. It  is  probably  the  most  common,  serious  dereliction  of 
duty  on  the  part  of  directors  to  allow  such  a  condition  as  this  to 
gradually  obtain  in  a  bank.  It  may  sometimes  be  done  honestly 
as  the  result  of  bad  judgment  only,  but  in  my  experience  it  is 
the  most  frequent  cause  of  dishonesty  and  fraud  among  bank 


ORGANIZATION  AND  BUSINESS  293 

officers.  I  do  not  remember  a  case  where  a  bank  officer  had  the 
moral  courage  to  let  loans  of  this  kind  carry  down  his  bank 
without  resorting  to  crimes  of  some  kind  to  conceal  or  postpone 
the  catastrophe,  in  hopes  that  some  fortunate  circumstance  might 
intervene  to  save  him  and  conceal  his  fraud. 

The  function  of  the  board  of  directors  is  to  assume 
the  responsibility  for  the  safety  of  the  bank  and  to  deter- 
mine the  general  policies  which  shall  be  pursued.  With 
the  active  conduct  of  the  business  it  has  nothing  to  do. 
This  function  is  delegated  to  the  officers,  the  chief  of 
whom  is  the  president. 

356.  The  president. — The  president  is  always  the  pre- 
siding officer  of  the  board  of  directors.     It  devolves 
upon  him  to  see  that  the  directions  of  the  board  are 
carried  out.     In  some  cases,  especially  where  there  is  a 
dummy  board  of  directors,  the  president  exercises  the 
whole  power.     In  other  cases  he  simply  carries  out  the 
will  of  the  board  in  the  administrative  details  without 
having  even  the  authority  to  grant  a  loan.     Usually  the 
powers  and  duties  of  the  president  lie  somewhere  be- 
tween these  two  extremes.     The  board  as  a  rule  deter- 
mines the  maximum  limits  to  which  credit  may  be 
extended  to  particular  firms,  and  leaves  the  president 
wide  discretion  in  granting  credits  between  these  limits. 

In  large  banks  there  are  vice-presidents  who  share 
with  the  president  the  duty  of  negotiating  with 
borrowers. 

357.  The  cashier. — The  cashier  of  the  bank  is  its  chief 
executive  officer,  upon  whom  falls  the  duty  of  operating 
the  bank.     He  has  direct  charge  of  all  the  employes 
and  must  of  course  be  familiar  with  the  details  of  every 
department.     He  usually  acts  as  secretary  of  the  board 
of  directors.     It  is  his  duty  to  prepare  the  reports  and 
statements.     He  is  the  officer  empowered  to  sign  docu- 


294  MONEY  AND  BANKING 

ments  on  behalf  of  the  bank.  His  signature  must 
always  appear  upon  the  circulating  notes  issued  or  the 
checks  and  drafts  drawn  by  the  bank  upon  its  corre- 
spondents. 

In  most  banks  which  have  not  yet  developed  a  special 
credit  department  the  cashier  is  the  chief  credit  officer. 
While  the  president  or  vice-president  usually  retains  the 
authority  to  grant  loans,  he  usually  depends  upon  the 
cashier  for  information  as  to  the  credit  responsibility 
of  the  applicant.  In  those  banks  where  the  list  of  bor- 
rowers has  become  extended  and  where  the  advantage 
of  a  credit  bureau  is  recognized,  the  cashier  frequently 
has  an  assistant  who  has  specialized  in  this  field  and  who 
understands  how  to  accumulate  and  systematize  informa- 
tion affecting  the  financial  status  of  the  patrons  of  the 
bank. 

The  credit  department  of  a  bank  probably  offers  more 
opportunity  for  an  employe  to  acquaint  himself  with 
the  science  of  banking  in  general  than  any  other  depart- 
ment. The  business  of  a  bank  is  of  such  a  routine  char- 
acter that  the  employes  have  very  little  opportunity  to 
learn  the  business  from  the  inside,  or  to  display  initiative, 
or  to  perform  duties  requiring  discretion.  Unlike  most 
businesses  there  is  no  line  of  positions  which  require 
successively  more  and  more  business  sagacity  on  the  part 
of  the  occupant.  The  gulf  between  the  highest  em- 
ploye and  the  officer  is  a  wide  one  and  very  difficult  to 
cross ;  in  most  large  city  banks  it  is  practically  impossible 
to  cross,  and  the  officers  are  usually  recruited  from  small 
institutions  where  the  employe  has  had  an  opportunity 
to  learn  all  departments  of  the  bank. 

358.  Paying  teller. — The  highest  employe  of  the 
bank  is  the  paying  teller.  He  has  charge  of  all  the  out- 
going funds  of  the  bank.  The  transactions  which 


ORGANIZATION  AND  BUSINESS  295 

require  the  paying  out  of  cash  are:  (1)  Cashing  of 
checks  presented  at  the  bank;  (2)  payment  of  debit  bal- 
ances to  the  clearing  house;  (3)  shipment  of  currency 
to  correspondent  banks.  It  is  the  duty  of  the  paying 
teller  to  see  that  all  the  cash  of  the  bank  is  properly 
accounted  for.  It  is  necessary  that  he  be  familiar  with 
the  signatures  of  all  the  depositors  so  that  he  may  make 
no  payments  without  having  proper  vouchers  to  show 
for  them.  Banks  are  under  legal  responsibility  to  de- 
positors to  pay  out  no  funds  on  their  account  except 
to  the  proper  payees  or  their  order.  Even  if  the  signa- 
ture on  the  check  is  genuine,  still  the  person  demanding 
payment  may  not  have  proper  title  to  the  check  or  he 
may  have  altered  it.  It  is,  therefore,  the  duty  of  the 
teller  to  safeguard  the  bank  by  requiring  proper  en- 
dorsement before  the  check  is  paid,  so  that  in  case  the 
depositor  attempts  to  repudiate  the  check  the  bank  can 
call  upon  the  payee  for  reimbursement. 

359.  Receiving  teller. — The  employe  second  in  im- 
portance is  the  receiving  teller.     Unless  there  is  a  note 
clerk  in  the  bank  it  is  the  duty  of  the  receiving  teller 
to  take  in  and  account  for  all  the  funds  which  come 
into  the  bank.     His  chief  duty  is  to  receive  cash,  checks, 
drafts,  and  other  items,  and  to  give  credit  to  depositors 
for  the  same.     His  principal  duty  is  to  assure  himself 
that  every  item  for  which  credit  is  given  is  collectible. 
Funds  come  into  the  bank  from   (1)   depositors,   (2) 
credit  balances  at  the  clearing  house,  (3)  payments  on 
maturing  paper  held  by  the  bank  either  as  an  asset  or 
for  collection,  and  (4)  currency  shipped  by  correspond- 
ent banks  or  by  the  Treasury  of  the  United  States. 

360.  Note  teller. — Where  the  business  of  a  bank  is 
extensive  enough  to  require  it,  there  is  a  note  teller 
whose  function  it  is  to  make  all  the  collections.     Matur- 


296  MONEY  AND  BANKING 

ing  notes  payable  at  the  bank  are  in  his  charge.  He 
receives  all  cash  remittances  from  out-of-town  customers. 
He  has  direct  charge  of  all  the  collections  of  drafts, 
etc.,  in  the  city,  except  the  checks  on  clearing  house 
banks,  which  are  usually  attended  to  by  the  clearing 
house  clerk. 

361.  Discount  clerk. — The  discount  clerk  has  charge 
of  all  the  loans  and  discounts  of  the  bank  after  they 
have  been  negotiated  by  the  officers.     It  is  his  duty  to 
keep  the  documents  so  systematically  that  there  will  be 
proper  presentation  made  of  them  when  they  mature. 
When  due  the  interest  is  calculated  and  the  note  turned 
over  to  the  note  teller  for  collection.     He  has  charge 
of  all  the  collateral  held  to  secure  loans  unless  the  bus- 
iness is  so  large  as  to  require  a  collateral  loan  clerk.     In 
banks  having  close  relations  with  stock  brokers  the  latter 
position  may  be  a  very  responsible  one.     The  collaterals 
held  to  secure  loans  to  stock  brokers  are  constantly  being 
withdrawn,  substituted  and  replaced.     Furthermore,  in 
times  of  active  speculation,  the  values  of  the  collaterals 
are  shifting  so  rapidly  that  the  collateral  loan  clerk  has 
great  responsibility  in  seeing  that  the  margin  of  security 
demanded  by  the  bank  is  maintained  and  the  call  for 
additional  collateral  is  properly  sent  out,  so  that  the 
borrower  can  have  no  grounds  of  complaint  if  the  bank 
finds  it  necessary  to  sell  the  collateral  to  protect  itself 
in  a  panicky  market. 

362.  Bookkeeping  department. — The  transactions  of 
all  the  tellers  and  other  clerks  are  finally  referred  to  the 
bookkeeping  department.     There  is  always  a  general 
ledger  of  the  bank  containing  the  accounts  summarized 
in  the  bank  statement.     It  is  the  duty  of  the  general 
bookkeeper  to  make  up  a  daily  statement  showing  the 
condition  of  the  bank  and  all  statements  required  by  the 


ORGANIZATION  AND  BUSINESS  291 

comptroller  of  the  currency.  The  bulk  of  the  book- 
keeping work  falls  upon  the  individual  ledger  keepers, 
whose  duty  it  is  to  charge  to  the  depositors'  accounts 
every  check  drawn  by  the  latter  and  to  credit  their  ac- 
counts with  all  the  deposits  reported  by  the  receiving 
teller.  The  bookkeeper  must  keep  the  paying  teller 
informed  as  to  the  balances  of  depositors. 

In  many  banks  there  is  a  separate  department  for 
handling  correspondence  and  the  collection  of  out-of- 
town  items.  It  has  become  the  custom  of  late  years  for 
remittances  to  be  made  in  checks  on  local  banks  rather 
than  in  New  York  exchange  or  money  orders  as  for- 
merly. In  some  cities  the  banks  are  so  anxious  to  secure 
the  deposit  accounts  of  large  firms  that  they  make  no 
charge  for  the  collection  of  local  checks,  although  this 
may  require  correspondence  with  a  multitude  of  banks 
in  all  parts  of  the  United  States. 

363.  Laws  relating  to  collections. — Every  deposit  in 
a  bank  other  than  cash  must  be  collected.  If  the  item 
is  a  check  on  the  bank  itself  or  a  matured  note  payable 
at  the  bank,  it  is  paid  as  soon  as  the  bank  gives  credit  to 
the  depositor.  But  if  the  items  are  payable  by  another 
party  the  bank  is  usually  considered,  in  the  absence  of 
a  special  agreement  and  when  the  items  are  endorsed  in 
blank  or  in  full,  to  be  the  bailee  of  the  depositor.  The 
deposit  is  in  fact  a  special  deposit  until  the  proceeds 
of  the  collection  are  lodged  in  the  bank  and  credited  to 
the  depositor,  whereupon  the  relation  between  bank  and 
depositor  changes  to  that  of  debtor  and  creditor. 

As  bailee,  the  bank  has  all  the  rights  to  the  paper 
held  and  may  sue  upon  it.  In  the  event  of  its  non-col- 
lection the  bank  may  rescind  the  credit  already  given  the 
depositor,  thus  proving  that  the  bank  had  not  purchased 
the  paper  and  taken  title. 


298  MONEY  AND  BANKING 

Insolvency  of  a  bank  revokes  its  power  to  collect  and 
it  must  hold  uncollected  paper  as  a  special  deposit  of  the 
owner.  If  it  receives  proceeds  of  a  collection  and 
mingles  them  with  the  general  funds  of  the  bank  it  is 
guilty  of  fraud. 

A  collecting  bank  should  accept  nothing  but  money 
in  payment  but  it  has  been  held  innocent  of  negligence 
when  it  had  taken  a  certified  or  even  an  uncertified  check 
which  it  presented  to  the  drawee  bank  without  delay 
and  the  taking  of  which  caused  no  loss  to  the  owner  of 
the  collection  item  by  reason  of  release  of  endorsers,  etc. 
Upon  non-payment  of  the  check  taken  in  payment  of 
the  collection  item  the  bank  should  recover  the  item  if 
possible  the  same  day  and  protest  it.  Payment  by 
worthless  check  is  no  payment  and  the  bank  could  pro- 
test the  item  even  if  the  payor  refused  to  give  it  up. 

If  a  collection  item  is  endorsed  "For  collection  and 
remittance,"  the  proceeds  become  a  part  of  the  general 
funds  of  the  bank  as  soon  as  a  draft  is  remitted,  and  if 
the  draft  proves  worthless  the  owner  of  the  collection 
cannot  claim  the  funds  as  a  special  trust  deposit. 

If  the  bank  has  collected  a  check  bearing  a  forged 
endorsement,  the  proceeds  belong  to  the  rightful  owner 
and  may  be  collected  by  him  although  the  bank  has 
turned  over  the  proceeds  to  the  person  depositing  the 
item. 

A  New  York  bank  received  a  "tramp"  collection  (one 
remitted  by  a  stranger  with  whom  it  had  no  account), 
collected  it,  deducted  its  collection  fee,  and  remitted. 
Later  it  turned  out  that  the  check  had  been  lost  in  the 
mail  after  being  endorsed  in  full;  the  thief  forged  the 
endorsement  and  sold  it  to  an  innocent  party  who  sent 
it  to  the  New  York  bank  for  collecting.  The  true  owner 


ORGANIZATION  AND  BUSINESS  299 

recovered  from  the  bank,  which  was  unable  to  locate  the 
person  to  whom  it  had  paid  the  proceeds. 

But  a  drawee  bank  cannot  collect  the  proceeds  of  a 
raised  check  from  a  collecting  bank  if  they  have  been 
paid  over  by  it  to  the  owner  of  the  item. 

364.  Liability  of  collecting  bank. — When  a  bank  un- 
dertakes to  collect,  it  makes  itself  liable  for  all  losses 
caused  by  its  negligence,  but  it  is  not  responsible  for 
the  negligence  of  a  notary  selected  by  it  with  ordinary 
care  because  the  notary  is  a  public  officer. 

The  law  varies  in  the  different  states  as  to  the  liability 
of  a  collecting  bank  for  banks  to  whom  it  sends  the  item 
in  course  of  collection.  In  the  federal  courts,  and  in 
Pennsylvania,  New  York,  New  Jersey,  Ohio,  Indiana, 
Michigan,  Montana,  and  Minnesota,  it  is  held  that  a 
collecting  bank  is  bailee  and  liable  for  the  agents  it  se- 
lects to  make  the  collection.  In  the  other  states,  the 
bank  is  held  to  be  the  agent  and  renders  itself  liable  for 
sub-agents  appointed  by  it  only  to  the  extent  of  using 
due  care  in  selecting  them;  beyond  this  the  sub-agents 
are  responsible  to  the  owner  and  may  be  sued  by  him. 
It  is  held  to  be  negligence  for  a  collecting  bank  to  remit 
the  item  directly  to  the  drawee  bank,  since  that  bank 
may  have  an  adverse  interest. 

Banks  do  not  succeed  in  avoiding  responsibility  by 
printing  in  the  pass  books  notices  that  they  will  not  be 
liable  for  the  acts  of  banks  to  whom  they  send  items. 
Such  contracts  have  been  held  to  be  void  by  the  courts 
on  the  same  principle  that  railroads  cannot  avoid  lia- 
bility for  accidents  to  persons  riding  on  passes  even 
though  the  pass  bears  on  its  face  such  a  disclaimer. 

If  a  note  is  payable  at  a  bank  and  funds  are  kept  to 
pay  it,  the  bank  is  the  agent  of  the  maker  and  if  the 


300  MONEY  AND  BANKING 

bank  fails  before  the  holder  of  the  note  gets  possession 
of  the  funds,  the  maker  is  liable  to  have  to  pay  the  note 
again. 

If  a  bank  collects  a  check  and  the  drawee  bank  dis- 
covers that  it  has  paid  by  mistake,  there  being  no  funds, 
the  collecting  bank  is  safe  in  returning  the  payment 
and  receiving  back  the  check.  The  endorsers  are  not 
released  even  though  the  maker  of  the  check  is  insolvent. 

The  cashier  of  a  bank  received  a  note  for  collection. 
The  maker  appeared  and  said  he  had  made  arrange- 
ments for  its  renewal.  The  cashier,  however,  insisted 
on  cash  payment,  which  was  made.  Next  morning  he 
received  instructions  to  return  the  note.  He  sent  the 
proceeds  instead.  He  would  not  have  been  justified  in 
repaying  the  sum  to  the  maker,  receiving  back  the  note 
and  forwarding  it. 

365.  Collection  of  out-of-town  checks. — The  collec- 
tion of  out-of-town  items  is  perhaps  one  of  the  heaviest 
expenses  of  a  bank.  It  has  been  calculated  that  the 
cost  of  collecting  an  item  averages  about  eighteen  cents 
divided  as  follows:  Exchange  .045  cents,  postage  and 
clerical  labor  .048,  interest  on  money  during  the  period 
of  collection  .085.  Small  banks  shift  the  expense  on- 
to the  larger  banks  by  keeping  accounts  with  them  and 
depositing  all  collection  items.  Large  city  banks  re- 
quire such  depositors  to  keep  balances  which  they  calcu- 
late are  large  enough  to  yield  a  profit  over  and  above 
the  expense  of  making  the  collections. 

The  economics  which  would  result  obviously  from  a 
system  of  collecting  country  checks  in  some  such  manner 
as  city  checks  are  now  collected  through  the  clearing 
houses,  has  led  to  many  schemes  being  proposed  but  none 
has  as  yet  been  adopted. 

It  was  proposed  in  Boston  that  one  bank  do  all  the 


ORGANIZATION  AND  BUSINESS  301 

collecting  for  the  city,  thus  avoiding  a  large  amount 
of  duplication  of  work  and  holding  the  country  banks 
to  stricter  terms  than  competing  city  banks  could  do 
individuals.  This  was  the  Suffolk  bank  system  applied 
to  check  collections.  The  scheme  failed  because  none 
of  the  banks  were  willing  to  give  any  one  bank  the  ad- 
vantage which  such  a  position  would  bring,  nor  to  give 
any  one  bank  the  opportunity  to  learn  so  much  about 
its  affairs  as  the  collection  of  its  items  would  give  it. 

To  avoid  these  difficulties  it  was  proposed  to  charter 
a  new  national  bank  for  the  purpose,  but  the  law  forbids 
national  banks  to  hold  stock  in  other  banks. 

Schemes  for  dividing  the  country  up  into  districts 
with  a  clearing  house  for  each  district  are  impracticable 
because  settlements  could  not  be  made  on  the  same  day 
and  it  would  be  necessary  for  each  member  to  keep 
funds  on  deposit  in  the  clearing  city  to  pay  balances 
against  them.  Furthermore,  the  pro  rata  expense  would 
be  considerable  whereas  now  the  country  banks  pay 
nothing  for  getting  their  collections  made  while  they  get 
fees  for  collecting  items  on  other  banks  in  their  vicinity 
or  even  on  themselves. 

366.  English  method  of  country  collections. — Each 
bank  in  London  receives  during  the  day  a  large  number 
of  checks  upon  country  bankers.  Upon  these  checks 
the  name  of  the  London  agent  is  printed.  Every  clear- 
ing banker  in  London  is  the  agent  for  one  or  more 
country  banks.  So  when  the  country  clerks  of  each 
bank  get  such  checks  from  the  cashiers,  correspondence 
department  and  other  sources,  they  proceed  to  arrange 
them  for  clearing  as  they  do  town  checks,  sorting  them 
and  putting  them  in  packages  according  to  the  London 
agencies  at  which  they  are  payable.  No  credit  is  given 
in  the  clearing  house  for  these  country  checks  on  the  day 


302  MONEY  AND  BANKING 

on  which  they  are  delivered.  The  amounts  are  simply 
settled  by  the  delivering  clerks  and  the  receiving  clerks, 
and  then  the  items  are  taken  to  the  respective  banks, 
whence  they  are  sent  by  mail  the  same  evening  to  the 
country  banks  by  whom  they  are  payable.  If  these 
checks,  reaching  their  destination,  are  found  to  be  all 
right,  they  are  credited  to  the  account  of  the  London 
agent  who  is  advised;  but  if  any  of  them  are  not  all 
right,  either  from  insufficient  funds  or  irregular  endorse- 
ment, or  any  other  cause,  such  irregular  checks  are  re- 
turned direct  to  the  banker  whose  crossing  they  bear. 
All  country  checks  not  returned  or  advised  by  the  morn- 
ing of  the  third  day  are  assumed  to  be  paid,  and  credit 
is  accordingly  given  for  them  in  the  clearing  of  that 
day  and  the  amount  is  settled  for,  along  with  those 
advised  paid,  in  the  final  balance.  All  country  checks 
held  by  London  bankers,  returned  unpaid,  must  be  re- 
turned into  the  hands  of  the  clerk  representing  the  deliv- 
ering bank  by  12 :30  on  the  third  day,  and  they  are  simply 
deducted  from  the  total  of  the  country  checks  on  the 
day  of  settlement. 


CHAPTER  XX 

DEPOSITS  AND  DEPOSITORS 

367.  General  deposits. — Deposits  are  of  two  kinds, 
general  and  special.    General  deposits  are  always  money 
or  the  right  to  receive  money.     They  create  between 
the  bank  and  the  customer  the  relation  of  debtor  and 
creditor.     The  relation  is  peculiar  in  that  the  bank  not 
only  contracts  to  pay  the  debt  on  demand  (unless  the 
deposit  is  a  time  deposit)  but  also  agrees  to  pay  to  the 
order  of  the  depositor  any  sums  within  the  total  amount 
of  the  deposit,  and  if  it  fails  to  do  so  it  may  be  sued 
in  damages  by  the  depositor.     The  bank  may  satisfy  the 
depositor  by  the  payment  of  legal  tender,  no  matter 
by  what  form  of  money  the  debt  was  created  or  how 
much  the  legal  tender  may  have  depreciated.     The  legal 
tender  acts  during  the  Civil  War  period  were  more  im- 
portant to  banks  than  any  other  class  in  the  community, 
these  acts  permitting  the  banks  to  pay  their  depositors 
depreciated  paper  money,  even  though  the  depositor 
had  deposited  gold.     At  that  time  it  was  the  custom 
among  the  banks  to  open  special  gold  accounts  all  the 
payments  on  which  should  be  made  in  gold. 

368.  Special  deposits. — A  special  deposit  may  consist 
of  anything  of  value  left  with  the  bank  for  safe  keeping. 
The  relation  between  the  bank  and  the  depositor  in  such 
a  case  is  that  of  bailee  and  bailor.    The  title  to  the  deposit 
does  not  pass  to  the  bank  as  in  the  case  of  a  general 
deposit,  but  rests  in  the  depositor.     The  bank  is  held  to 
use  only  ordinary  care  in  protecting  it  and  if  it  is  stolen 

303 


304  MONEY  AND  BANKING 

without  negligence  on  the  part  of  the  bank,  the  owner 
must  bear  the  loss.  The  banker  must  return  to  the  de- 
positor the  identical  thing  deposited.  If  the  bank  ac- 
cepts a  consideration  for  keeping  the  deposit,  it  is  held 
by  law  to  exercise  greater  care. 

369.  Safety  deposit  vaults. — Because  the  banker  was 
the  only  business  man  in  the  smaller  places,  possessing 
a  safe,  it  was  formerly  the  custom  for  him  to  receive  the 
valuables  of  customers  for  safe  keeping.     Nowadays  the 
banks  derive  a  profit  from  the  function  which  was 
formerly  a  source  of  great  annoyance  to  them,  and  they 
have  established  safety  deposit  vaults  the  boxes  of  which 
are  rented  by  the  year.     These  vaults  are  not  only  profit- 
able on  account  of  the  rentals  they  earn  but  also  because 
they  act  as  a  feeder  to  the  bank.     Many  people  who 
will  not  trust  the  bank  with  their  money  will  rent  a  box. 
This  brings  them  into  touch  with  the  officials  of  the 
bank,  and  as  a  rule  whatever  suspicion  they  had  grad- 
ually disappears,  so  that  ultimately  they  become  regular 
depositors  either  in  the  savings  or  commercial  depart- 
ment, especially  if  the  bank  pays  interest  on  deposits. 

370.  Inducements  to  depositors. — We  learned  in  the 
preceding  chapter  that  a  cash  deposit  enables  the  bank 
to  earn  credit  from  three  to  six  times  its  amount.     It 
is  quite  possible  for  a  bank  to  make  15  to  20  per  cent  on 
the  deposits  left  with  it.     Hence  there  is  great  competi- 
tion among  banks  for  deposit  accounts  which  are  likely 
to  be  fairly  permanent.     In  return  for  the  use  of  the 
general  deposit  which  is  so  profitable,  banks  have  been 
led  by  competition  among  themselves  to  offer  many 
valuable  services  to  the  depositor.     Among  these  are  the 
following : 

(a)   Checks. — It  pays  the  checks  of  the  depositor, 
taking  the  risk  of  their  being  genuine  and  that  the  money 


DEPOSITS  AND  DEPOSITORS  305 

is  paid  to  the  person  designated  by  the  depositor  or 
his  order.  This  service  is  of  great  value  to  the  depositor 
as  it  saves  him  the  inconvenience  and  the  expense  of 
making  cash  payments. 

(b)  Collections. — The  bank  collects  the  checks  and 
all  other  items  of  credit  for  the  depositor,  often  at  con- 
siderable  expense.     It   offers   the   depositor   a   cheap 
and  easy  way  to  collect  accounts  due  by  drawing  sight 
drafts  on  his  debtor  and  collecting  them  through  his 
bank.     Since  the  growth  of  the  custom  of  sending  local 
checks  in  making  small  payments  to  city  houses,  such 
for  example  as  the  one  dollar  subscription  to  magazines, 
the  associated  banks  in  several  of  the  larger  cities  have 
been  compelled  to  establish  a  uniform  fee  for  collecting 
out-of-town  checks,  the  rate  usually  being  10  per  cent, 
with  a  minimum  charge  of  10  cents  per  check. 

(c)  Safety. — The  bank  relieves  the  depositor  of  the 
risk  of  caring  for  his  money. 

(d)  Loans. — The  bank  usually  feels  under  obliga- 
tion to  loan  to  a  depositor   on   more   advantageous 
terms  and  usually  on  less  rigid  requirements  than  to 
non-depositors.     It  can  do  so  because  it  is  more  or  less 
acquainted  with  the  affairs  of  the  depositor  and  can 
accept  personal  credit  when  other  parties  would  require 
collateral  security.     The  greatest  advantage,  however, 
comes  in  times  of  panic  when  funds  are  needed  most 
and  when  all  the  banks  are  refusing  to  loan  to  others 
than  their  depositors. 

(e)  Interest    on    balances. — Sometimes    the    banks 
pay  interest  on  the  daily  balances.     This  practice  was 
an  innovation  of  the  trust  companies  and  was  due  to  the 
fact  that  the  deposits  in  the  banking  department  of 
the  earlier  trust  companies  were  practically  time  de- 
posits.    When  the  character  of  the  deposits  gradually 

VII— 20 


306  MONEY  AND  BANKING 

changed  the  custom  still  prevailed,  much  to  the  vexation 
of  the  national  banks. 

(f)  Increases  credit. — The  banking  connection  fre- 
quently increases  the  credit  of  the  business  man.  A 
good  banking  reference  is  frequently  of  great  advantage 
in  business,  and  the  banks  must  be  constantly  on  their 
guard  against  persons  who  use  their  connection  with  the 
bank  to  gain  unmerited  credit. 

371.  Difficulties  in  establishing  a  new  bank. — It  is 
very  difficult  to  establish  a  new  bank  in  a  community 
already  supplied.     If  the  old  banks  are  not  willing  to 
accommodate  their  customers  freely,  and  if  they  charge 
for  making  collections  or  refuse  to  loan  except  on  oner- 
ous terms  as  to  rate  and  security,  a  new  institution  may 
attract  many  depositors  by  superior  inducements,  par- 
ticularly by  paying  interest  on  deposits.     Too  many 
concessions,  on  the  other  hand,  may  cause  the  new  bank 
to  lose  credit  for  soundness;  it  may  be  inclined  to  take 
great  risks  in  loaning  in  order  to  recover  the  amounts 
paid  out  as  interest  to  depositors  and  in  the  expensive 
services  performed  for  them.     There  usually  is  no  diffi- 
culty in  finding  borrowers  for  the  funds  of  the  new 
bank;  in  every  community  there  are  always  business  men 
of  unsound  methods  who  have  been  refused  credit  by 
the  old  banks  and  who  welcome  the  appearance  of  a 
new  bank,  hoping  to  establish  relations  with  it.     They 
try  to  place  the  bank  under  obligations  by  opening  de- 
posit accounts. 

372.  Value  of  a  banking  connection. — Many  well  es- 
tablished banks  are  enabled  to  hold  their  depositors  with- 
out paying  interest  on  deposits  against  the  competition 
of  the  trust  companies  because  they  offer  the  depositor 
something  of  more  value  to  him  than  the  interest, 


DEPOSITS  AND  DEPOSITORS  307 

namely,  credit  in  time  of  need.  When  a  panic  comes 
and  even  strong  business  concerns  are  in  danger  of 
bankruptcy  through  temporary  need  of  funds,  the  op- 
portunity of  the  bank  to  render  service  is  very  great. 
A  small  loan  at  the  proper  time  may  count  for  more 
than  interest  on  deposits  for  many  years.  Depositors 
remain  loyal  to  old  conservative  banks,  knowing  that 
the  banks  will  probably  have  a  chance,  sometime,  to 
render  reciprocal  service.  However,  as  business  con- 
cerns grow  richer  and  less  dependent  upon  bank  credit 
for  existence  this  inducement  will  lose  its  force. 

373.  Kiteing  checks  and  drafts. — The  practice  of 
"kiteing"  is  a  source  of  great  annoyance  to  banks.     It 
is  practiced  by  depositors  who  wish  to  gain  the  use  of 
funds  for  a  short  time  without  payment  of  interest.     It 
is  possible  to  accomplish  this  because  of  the  custom  of 
banks  of  giving  credit  immediately  upon  deposit  for 
checks  and  drafts,  even  though  they  are  drawn  on  dis- 
tant cities.     Kiteing  requires  the  collusion  of  two  parties 
located  some  distance  apart.     It  can  be  most  easily  done 
between  branches  of  the  same  concern. 

374.  Method  of  "kiteing." — To  illustrate  the  practice 
let  us  assume  that  a  depositor  in  New  York  draws  a 
sight  draft  or  deposits  a  check  received  from  a  con- 
federate in  San  Francisco.     The  bank  will  permit  the 
New  York  depositor  to  check  against  the  credit  even 
though  the  bank  will  not  realize  the  proceeds  of  the 
check  or  draft  within  one  or  two  weeks.     It  will  require 
at  least  a  week  for  the  check  or  draft  to  reach  San  Fran- 
cisco and  be  presented  to  the  confederate  for  payment. 
Anticipating  the  arrival  of  the  bill  against  him  the  con- 
federate will  provide  credit  at  his  bank  by  depositing 
there  a  draft  or  check  on  a  third  confederate,  perhaps 


308  MONEY  AND  BANKING 

in  New  Orleans.  Thus  two  or  three  persons  may  have 
the  use  of  considerable  sums  of  money  for  some  time 
without  payment  of  interest  or  principal. 

375.  Title  to  deposited  checks,  etc. — The  title  to  paper 
deposited  in  a  bank  often  becomes  an  important  ques- 
tion.    It  is  a  rule  of  law  that  if  the  items  deposited  in 
a  bank  are  for  collection  and  not  for  credit  on  the  reg- 
ular account,  the  title  does  not  pass  to  the  bank  but 
remains  in  the  depositor  until  the  proceeds  have  arrived 
at  the  bank.     In  this  case  the  bank  is  simply  the  agent 
of  the  owner,  and  the  proceeds  of  the  collection  are 
trust  funds  which,  if  they  can  be  traced,  must  be  re- 
turned to  the  owner  in  spite  of  insolvency  of  the  parties 
holding  them.     If  the  paper  is  endorsed  "for  collection" 
there  is  no  doubt  as  to  the  ownership,  but  when  it  is 
endorsed  in  full  or  in  blank  the  ownership  depends  en- 
tirely upon  the  agreement  between  the  depositor  and 
the  bank.     If  no  agreement  has  been  made  the  law  holds 
that  the  deposit  is  for  credit  and  that  the  bank  acquires 
title.     If  the  bank  should  fail  the  depositor  must  take 
his  chances  with  the  other  depositors,  but  if  the  agree- 
ment has  been  that  the  items  deposited  are  for  collec- 
tion, or  if  they  have  been  endorsed  plainly  "for  col- 
lection," the  depositor  is  a  preferred  creditor  and  is  paid 
before  all  other  depositors. 

.Unless  the  item  is  endorsed  "for  collection"  or  they 
have  notice  otherwise,  innocent  third  parties  who  con- 
sider the  item  the  property  of  the  bank  and  seize  it  to 
pay  any  debts  of  the  bank  then  having  it,  cannot  hold 
to  the  rule  longer.  The  law  on  this  point  was  clearly 
laid  down  in  the  case  of  Doppelt  v.  National  bank  of 
the  Republic.1 

376.  Case  of  disputed  ownership  to  deposited  check. 

i  No.  1,  National  Bank  Cases. 


DEPOSITS  AND  DEPOSITORS  309 

— Doppelt  deposited  with  his  bank  a  check  endorsed  in 
blank  for  collection.     The  bank  endorsed  the  check  "For 

collection  to  the  credit  of Bank,"  (inserting  its  own 

name) ,  and  sent  it  to  the  National  Bank  of  the  Republic. 
Doppelt's  bank  failed  the  next  day  owing  a  considerable 
amount  to  the  National  Bank  of  the  Republic.  The 
latter  seized  the  proceeds  of  the  check  after  it  had  been 
collected  in  order  to  satisfy  the  debt  due  it.  Doppelt 
sued  the  National  Bank  of  the  Republic  for  the  funds, 
claiming  that  his  own  bank  had  acquired  no  title  to 
the  check.  Regardless  of  the  agreement  between  him- 
self and  his  bank,  Doppelt  could  not  recover  because  the 
National  Bank  of  the  Republic  had  no  notice,  nor  could 
it  have  learned  from  the  endorsement  of  Doppelt's  bank, 
that  it  was  not  the  owner  of  the  check.  The  law  per- 
mitted the  National  Bank  of  the  Republic  to  regard 
the  check  as  being  the  property  of  Doppelt's  bank. 

377.  Accepting  deposits  when  insolvent  is  criminal. — 
The  receipt  of  deposits  by  an  insolvent  bank  is  clearly 
a  fraud  and  the  officers  who  take  deposits  are  guilty 
of  criminal  offense,  punishable  by  imprisonment.     In 
convicting  an  officer  of  a  bank  of  this  charge  it  is  neces- 
sary to  prove  that  he  knew  the  bank  to  be  insolvent  when 
he  received  the  deposit.     The  insolvency  of  a  bank  is  a 
very  difficult  matter  to  determine  sometimes,  because  it 
depends  upon  the  value  of  the  loans  and  discounts  in 
its  assets.     While  the  officers  may  know  that  some  of 
the  loans  are  not  first  class  and  may  not  be  paid  promptly 
yet  they  may  believe  them  to  be  good  ultimately. 

378.  Drawer  released  from  responsibility  after  rea- 
sonable time. — The  drawer  of  a  check  is  always  liable 
for  the  ultimate  payment  in  case  the  bank  should  fail 
before  it  is  cashed.     However,  in  order  to  protect  the 
drawer  of  checks,  the  law  requires  that  a  check  must  be 


310  MONEY  AND  BANKING 

presented  to  the  bank  for  payment  within  a  reasonable 
time,  otherwise  the  holder  of  the  check  must  assume  the 
risk  of  the  failure  of  the  bank. 

379.  Local  banks. — In  the  case  of  a  local  bank  the 
courts  have  held  that  a  reasonable  time  means  until  the 
close  of  the  business  day  following  the  delivery  of  the 
check.     If  the  payee  should  endorse  it  to  another  party 
on  the  second  day  and  the  endorsee  should  hold  it  still  an- 
other day  before  presenting  it,  the  bank  failing  in  the 
meantime,  the  original  drawer  would  be  released  and  the 
payee  be  compelled  to  reimburse  the  holder  or  endorsee, 
because  the  latter  had  presented  it  for  payment  within  a 
reasonable  time  after  receiving  it.     In  the  case  of  checks 
drawn  on  banks  outside  the  city  in  which  the  drawer 
resides,  the  check  must  be  forwarded  on  its  way  before 
the  close  of  the  next  business  day  in  order  to  hold  the 
drawer  responsible. 

380.  Holder  of  a  check  can  not  sue  bank. — In  nearly 
every  state  a  bank  on  which  a  check  is  drawn  is  under 
no  legal  obligation  to  the  holder  to  pay  or  accept  it, 
whether  the  maker's  funds  are  sufficient  for  this  .purpose 
or  not.     Of  course  if  the  bank  has  accepted  the  check 
by  certification,  then  the  holder  has  a  claim  against  the 
bank.     If  a  bank  should  decline  without  a  valid  reason 
to  pay  a  check  drawn  on  a  sufficient  fund  belonging  to 
its  depositor  the  institution  would  be  liable  for  whatever 
injury  the  depositor  sustained.     For  example,  should 
a  bank  decline  to  pay  a  check  supposing  that  the  maker's 
deposit  was  insufficient  when  in  truth  it  was  ample,  the 
institution  would  be  liable  for  the  consequences  of  thus 
dishonoring  his  order,  even  though  its  conduct  was 
founded  on  the  mistaken  calculation  of  a  bookkeeper. 

381.  Revocation. — The  depositor  has  the  privilege  of 
stopping  payment  on  a  check,  and  the  bank  will  be 


DEPOSITS  AND  DEPOSITORS 

liable  for  the  amount  if  it  pays  the  check  in  spite  of  the 
stop  order. 

The  death  of  a  depositor  works  a  revocation  of  all  F 
the  checks  not  yet  paid  just  as  soon  as  the  bank  receives 
notice  of  his  death. 

382.  Insufficient  funds. — If  the  credit  account  of  the 
depositor  is  insufficient  to  pay  the  full  amount  of  the 
check,  the  bank  has  no  right  to  pay  a  part  of  the  sum 
with  the  funds  on  hand.     On  one  occasion  when  a  bank 
refused  to  pay  a  check  where  the  funds  to  the  credit 
of  the  depositor  were  insufficient,  the  holder  of  the  check, 
fearing  that  if  there  was  delay  he  might  not  receive  any- 
thing on  account  of  the  embarrassment  of  the  drawer, 
deposited  to  the  account  of  the  drawer  a  sum  sufficient 
to  cover  the  amount  of  the  check.     Thereupon  the  bank 
had  no  right  to  refuse  payment. 

383.  Forgeries. — The  bank  is  presumed  to  know  the 
signatures  of  its  depositors  and  it  cannot  pay  a  forged 
check  and  charge  the  account  of  the  depositor  with  the 
amount  of  the  check.     The  principal  exception  to  this 
rule  is  in  the  case  of  a  check  so  negligently  drawn  that 
an  alteration  is  easily  made.     The  bank  that  pays  a 
forged  check  cannot  recover  the  money  from  the  inno- 
cent payee.     This  seems  a  hard  rule  as  both  are  innocent, 
but  as  greater  vigilance  on  the  part  of  the  bank  might 
have  discovered  the  forgery  it  must  be  held  responsible. 

384.  Post-dating. — Sometimes  checks  are  post-dated, 
that  is,  bear  a  later  date  than  the  one  on  which  they  are 
written.     The  object  of  this  is  to  obtain  delay  in  mak- 
ing payment,  the  drawer  simply  desiring  time  in  which 
to  have  the  money  in  the  bank's  possession  on  the  date 
specified.     The  bank  that  pays  an  altered  post-dated 
check  before  its  due  date  cannot  check  the  amount 
against  the  drawer.     In  no  case  can  a  check  paid  before 


312  MONEY  AND  BANKING 

the  time  specified  be  charged  to  the  drawer's  account. 

385.  Set-off. — The  relation  between  the  bank  and 
depositor  is  that  of  debtor  and  creditor ;  therefore  either 
party  has  the  right  to  set  off  his  debt  to  the  other  with 
any  claim  he  may  have  against  him  or  it.     For  instance, 
if  A  has  a  deposit  of  $100  in  a  bank,  the  bank  is  his 
debtor  for  that  sum ;  but  if  the  bank  holds  an  unsecured 
and  matured  note  against  A  for  $50  the  debt  of  the 
bank  to  A  is  only  $50 — the  difference  between  the  credits 
and  debits. 

386.  When  a  depositor  fails,  his  note  not  being  se- 
cured.— This  point  is  of  considerable  consequence  when 
one  or  another  of  the  parties  have  become  insolvent.     If 
the  depositor  fails  owing  the  bank  on  an  unsecured  note, 
whether  matured  or  umnatured,  the  bank  can  seize  the 
deposit  to  satisfy  the  note  unless  somebody  has  a  prior 
lien  upon  it,  for  instance,  an  attachment;  or  in  Illinois, 
South  Carolina,  Kentucky,  Nebraska,  or  Texas  when 
a  check  operates  as  an  assignment  of  so  much  of  the 
deposit,  a  check  holder,  after  he  presented  the  check, 
would  have  a  claim  superior  to  that  of  the  bank.     Since 
insolvency  caused  all  unmatured  obligations  of  the  in- 
solvent person  to  become  at  once  due  and  payable,  the 
bank  could  apply  a  deposit  on  such  a  note.     If  the  note 
has  security  the  bank  must  first  satisfy  the  note  from 
the  security. 

387.  Advantage  to  depositor. — If  the  bank  should 
fail  the  depositor  may  set  off  his  note  to  the  bank  with 
his  deposit.     The  receiver  cannot,  of  course,  enforce 
collection  on  the  note  until  it  matures  but  the  depositor 
has  his  claim  against  the  bank  whenever  the  note  is 
presented  to  him.     The  receiver  cannot  avoid  this  set- 
off  by  selling  the  note  to  an  innocent  third  party,  for  the 
fact  that  the  note  was  purchased  from  a  receiver  would 


DEPOSITS  AND  DEPOSITORS  313 

be  notice  of  irregularity.  If  a  note  after  maturity  was 
negotiated  by  one  bank  to  another  and  the  first  bank 
failed  holding  a  deposit  of  the  maker  of  the  note,  the 
maker  could  use  his  deposit  to  off-set  the  note,  because 
the  second  bank  was  not  a  bona  fide  holder  and  took  the 
note  subject  to  all  equities  between  the  maker  and  the 
first  bank. 

388.  Set-off  makes  failures  appear  worse. — Since  a 
large  portion  of  the  loans  of  a  bank  are  made  to  de- 
positors, whenever  a  bank  fails  a  considerable  part  of 
the  assets  are  canceled  by  an  equal  amount  of  liabilities 
in  the  shape  of  deposits.     Depositors  who  are  also  bor- 
rowers are  really  in  the  position  of  preferred  creditors 
for  their  deposits  and  they  gain  at  the  expense  of  de- 
positors who  are  not  also  borrowers.     Therefore,  in  a 
bank  failure  where  a  50  per  cent  dividend  is  paid  to  de- 
positors, the  failure  is  not  so  bad  as  this  figure  indicates, 
for  a  large  number  of  depositors  may  also  have  been  bor- 
rowers and  have  lost  little  or  nothing. 

389.  Illustration. — A  bank  with  $1,000,000  loans  and 
$1,000,000  deposit  liabilities  fails.     If  half  the  loans  are 
offset  by  deposits  there  remain  $500,000  of  loans  with 
which  to  pay  $500,000  deposits.     Suppose  the  loans 
realize  50  per  cent  of  their  face  value  when  liquidated, 
there  would  then  be  $250,000  to  be  distributed  to  depos- 
itors, or  a  50  per  cent  dividend.     If  the  depositors  who 
were  also  borrowers  had  not  been  allowed  to  offset  their 
obligations  with  their  deposits,  the  assets  collected  would 
have  been  $750,000,  which  would  have  been  distributed 
among  all  the  depositors  having  claims  of  $1,000,000; 
that  is,  each  depositor  would  have  received  a  75  per  cent 
dividend.     This  explains  why  failures  are  not  as  bad 
as  the  percentage  of  dividends  indicates. 

390.  Form  of  note. — Some  banks  use  a  form  of  note 


314.  MONEY  AND  BANKING 

similar  to  the  following  in  which  the  borrower  specifically 
agrees  to  permit  the  bank  to  transfer  to  itself  in  case 
of  his  insolvency  any  deposit  credit  or  other  form  of 
indebtedness : 


$ EVAHSTON,   ILL., 19.. 

after  date promise  to  pay  to  the  order  of 

STATE  BANK  OF  EVANSTON, 

DOLLARS 

With  interest  at per  cent,  per  annum  after at  the  office 

of  said  Bank.  Value  received.  In  case  of  the  insolvency  of  the 
undersigned  any  indebtedness  due  from  the  legal  holder  hereof  to 
the  undersigned  may  be  appropriated  and  applied  hereon  at  any  time, 
as  well  before  as  after  the  maturity  hereof. 

No... 


CHAPTER  XXI 

LOANS  OF  THE  BANK 

391.  Two  qualities  necessary  to  the  making  of  a 
banker. — The  successful  banker  who  has  the  entire  re- 
sponsibility of  his  bank  upon  his  own  shoulders  must  pos- 
sess two  qualifications   almost  opposite   in   character. 
Under  former  conditions  conservatism  was  the  distin- 
guishing quality  of  a  good  banker  but  with  keen  compe- 
tition in  the  business  he  must  add  to  conservatism  in 
granting  loans,  aggressiveness  in  securing  deposits.     In 
a  large  bank  the  two  functions  can  be  specialized  in  dif- 
ferent men.     The  point  of  view  of  the  official  who  makes 
the  loans  should  be,  first,  to  avoid  losses  and,  second,  to 
make  money;  in  these  good  judgment  is  more  to  be  de- 
sired than  enterprise. 

Mr.  William  Law,  vice-president  of  the  Central  Na- 
tional Bank  of  Philadelphia,  in  an  unpublished  address, 
has  made  a  fourfold  classification  of  bank  borrowers. 

392.  Investment  loans. — First,  investment  borrowers 
— parties  who  borrow  to  invest  the  funds  of  the  bank 
in  certain  securities  or  property  which  they  wish  to  carry 
with  a  view  of  reselling  at  a  profit,  or  of  holding  until 
funds  can  be  accumulated  to  pay  for  the  purchase,  or 
of  enabling  the  holder  to  gain  certain  control  or  influ- 
ence, or  of  otherwise  accomplishing  some  object  external 
to    the   transaction.     Such    are    the    loans    ordinarily 
granted  brokers,  investment  bankers,  and  market  opera- 
tors.    These  loans  can  be  readily  realized  upon  in  pro- 
portion to  the  convertibility  or  salability  of  the  collateral ; 

315 


316  MONEY  AND  BANKING 

that  is  to  say,  under  normal  conditions  such  a  borrower 
will  pay  his  loan  at  one  bank  by  selling  the  securities 
pledged  there  or  by  borrowing  from  another  bank. 

893.  Conditions  under  which  they  are  good  banking 
loans. — Loans  of  this  character,  if  they  are  obligations 
of  active  and  capable  men,  and  especially  if  payable  on 
demand  and  secured  by  well-distributed  and  properly 
margined  collaterals  possessing  a  broad  market,  are  an 
excellent  investment  for  a  portion  of  the  funds  of  a 
bank.  However,  when  money  is  redundant  such  loans 
at  times  yield  a  lower  rate  of  interest  return  than  the 
rate  paid  by  banks  in  reserve  and  central  reserve  cities 
upon  the  daily  balances  of  their  out-of-town  correspond- 
ents. In  recent  years  the  rates  upon  such  loans  have 
ranged  from  1%  to  2  per  cent  for  several  consecutive 
months.  In  times  of  great  financial  stringency  reali- 
zation upon  such  loans  is  often  exceedingly  difficult. 
The  bank  having  loans  secured  by  a  large  line  of  certain 
securities  may  hesitate  to  force  their  sale,  fearing  to 
break  the  market  and  thus  reduce  the  market  value  of 
similar  securities  on  other  loans  or  injure  the  market 
price  of  securities  belonging  to  their  friends  and  business 
associates;  but  we  are  compelled  to  recognize  the  fact 
that  under  our  system  of  a  bond-secured,  non-elastic 
currency,  with  its  well-known  central  reserve  city  and 
reserve  city  features,  call-loans  upon  stock  exchange 
collateral  afford  a  reasonably  safe  and  exceedingly  con- 
venient method  of  utilizing  that  portion  of  the  loanable 
funds  of  an  active  bank  in  a  financial  center  which  is  not 
employed  in  caring  for  the  requirements  of  its  borrow- 
ing dealers. 

394.  Industrial  loans. — Second,  automatic  or  seasonal 
borrowers.  By  these  terms  it  is  intended  to  describe  the 
operations  of  manufacturers,  merchants,  farmers,  dro- 


LOANS  OF  THE  BANK  317 

vers,  and  other  like  borrowers  who  require  temporary 
accommodation  during  a  period  of  production,  transpor- 
tation, distribution,  or  collection.  To  illustrate:  A 
converter  of  cotton  goods  must  pay  the  commission  mer- 
chant or  manufacturer  for  his  raw  material,  for  instance, 
gray  goods,  within  ten  days  after  purchase.  The  proc- 
ess of  bleaching,  dyeing,  and  finishing  may  consume 
sixty  days;  the  process  of  distribution  among  and  col- 
lection from  the  dry  goods  wholesalers  who  purchase 
the  finished  product  will  require  at  least  sixty  days  more. 
Funds  loaned  a  borrower  of  this  description  should  be 
automatically  returned  with  the  completion  of  the  trans- 
action. Or  a  company  operating  grain  elevators  in 
Minneapolis  ships  wheat  in  carload  lots  to  a  Philadel- 
phia grain  exporter,  asking  its  local  bank  to  discount 
the  bill  of  lading  draft  created  by  the  transaction.  The 
completion  of  this  purchase  by  the  sale  of  the  sterling 
grain  bill  automatically  returns  to  the  bank  the  money 
borrowed.  From  the  standpoint  of  a  commercial  banker 
loans  of  this  character  constitute  the  ideal  bank  credit. 
Banks  are  to  be  envied  when  a  large  part  of  their  funds 
are  utilized  by  local  dealers  engaged  in  producing, 
marketing,  and  distributing  the  great  staples  that  the 
people  consume,  as  food,  clothing,  heat,  and  light.  A 
bank  so  located  will  continue  its  usual  business  whether 
or  not  there  is  a  panic  on  Wall  Street,  whether  or  not 
the  financial  leaders  are  hurrying  to  Washington, 
whether  or  not  there  are  eager  buyers  for  life's  light 
luxuries. 

A  favorite  form  of  loans  of  this  sort  are  the  re-dis- 
counts of  other  banks,  especially  if  the  borrowing  banks 
are  located  in  sections  where  seasonal  borrowing  is  the 
usual  rule  and  are,  therefore,  themselves  seasonal  or 
temporary  borrowers.  The  risk  involved  is  small  and 


318  MONEY  AND  BANKING 

proceeds  of  re-discounts  are  apt  to  remain  on  credit 
with  the  lending  bank  in  much  larger  proportion  than 
are  the  proceeds  of  ordinary  loans.  A  bank  usually 
borrows  to  increase  its  reserves;  a  firm  usually  borrows 
to  pay  out  the  proceeds. 

The  above  mentioned  two  classes  are  considered  most 
desirable  loans ;  the  two  following  less  desirable. 

395.  Capital  loans. — Third,  capital  borrowers.     This 
phrase  is  intended  to  describe  the  borrowing  of  perma- 
nent capital  for  a  business  to  be  repaid  from  earnings 
or  profits  as  they  accumulate,  and  the  natural  results 
are  continuous  loans  and  over-trading.     For  instance: 
The  president  of  a  manufacturing  corporation,  in  con- 
structing a  new  plant,  finds  that  its  cost  exceeds  the 
capital  subscribed  by  the  stockholders.     He  borrows  the 
necessary  money  by  issuing  notes  which  are  discounted 
by  a  friendly  bank.     This  loan  can  be  extinguished  only 
by  borrowing  elsewhere,  by  continuous  operation  at  a 
profit,  or  by  the  sale  of  the  plant. 

396.  Capital  should  come  from  stock  and  bond  issues. 
— The  weakness  of  this  position  would  quickly  be  made 
manifest  should  manufacturing  operations  cease.     All 
capably  managed  banks  discourage  such  loans  in  any 
substantial  measure  unless  conditions  are  unusually  fa- 
vorable for  continued  high  earnings  which  can  be  ap- 
plied to  reducing  steadily  such  a  loan  within  a  reasonable 
time.     Capital  for  requirements  of  this  character  should 
be  provided  by  additional  subscriptions  of  stockholders 
or  by  sales  of  bond  issues.     That  is  to  say,  the  funds 
should  be  held  in  the  form  of  permanent  or  long  term 
borrowing  at  the  option  of  the  borrower  through  bonds 
secured  by  mortgage. 

This  idea  is  concisely  expressed  by  the  advertisement 
of  a  prominent  Chicago  bank :     "Conservative  banking 


%  LOANS  OF  THE  BANK  319 

consists  in  caring  for  many  interests,  while  capitalizing 
none."  The  statement  of  a  strongly  organized  manu- 
facturing corporation  or  firm  indicates  quickly  convert- 
ible assets  abundantly  sufficient  to  protect  all  quick 
liabilities.  Of  course,  from  the  standpoint  of  the  man- 
ufacturer engaged  in  a  highly  profitable  line  of  work, 
the  temptation  is  alluring  to  endure  for  a  period  the 
sacrifices,  buffetings,  and  annoyances  of  carrying  what 
is  termed  a  plant  debt,  knowing  that  he  will  thereby  be 
enabled  to  maintain  permanently  a  low  capitalization 
and  thus  render  the  task  of  dividend  earning  lighter  for 
all  time  to  come  when  the  plant  debt  shall  once  have  been 
extinguished  out  of  earnings. 

397.  Mortgage  loans. — Fourth,  long  time  or  perma- 
nent borrowers  on  mortgage.  To  this  class  belong  the 
holders  of  improved  and  productive  central  real  estate 
in  the  larger  cities.  Though  these  loans  command  low 
rates  by  reason  of  the  stable  value  of  the  security,  na- 
tional banks  are  prohibited  from  taking  them  directly, 
except  to  secure  a  debt  previously  existing,  and  are 
criticised  severely  for  taking  them  indirectly.  These 
loans  are  generally  placed  with  corporations  controlling 
trust  or  permanent  funds,  such  as  life  and  fire  insurance 
companies,  savings  banks,  and  trust  companies.  The 
degree  to  which  these  loans  are  encouraged  by  our  laws 
and  the  ease  with  which  money  can  be  borrowed  in  round 
amounts  upon  improved  central  real  estate  in  our  larger 
cities,  possibly  affect  the  advance  in  real  estate  values 
as  directly  as  the  increase  in  population  and  wealth. 
Building  and  loan  associations  afford  the  most  effective 
plan  for  handling  small  real  estate  loans.  In  this  classi- 
fication may  be  included,  for  some  reasons,  the  bonds 
constituting  preferred  liens  upon  high  class  railroad 
and  traction  properties.  But  their  ready  convertibility 


320 


MONEY  AND  BANKING 


renders  them  also  acceptable  as  a  bank  investment,  and 
they  are  favored  by  the  national  banking  system  in  that 
the  rule  regarding  excess  loans  is  not  applied  to  them. 

398.  Loans  reported  to  the  comptroller. — The  fol- 
lowing classification  is  used  by  the  Comptroller  of  the 
Currency  in  the  reports  required  of  national  banks. 
Comparison  is  made  with  the  statement  of  ten  years 
previous : 


1897. 

1903. 

1907. 

Class. 

Amount  in 

Per 

Amount  in 

Per 

Amount  in 

Per 

Dollars. 

Cent. 

Dollars. 

Cent. 

Dollars. 

Cent. 

On  demand, 

paper  with 

, 

one  or  more 

individual  or 

firm  names. 

103,837,578 

5.1 

374,689,245 

8.7 

428,221,535 

9.2 

On  demand, 

secured  by 

stocks, 

bonds  and 

other  per- 

sonal 

securities  .  . 

326,447,852 

15.9 

828,016,734 

19.3 

882,878,479 

17.8 

On  time, 

paper  with 

two  or  more 

individual  or 

firm  names. 

896,099,397 

43.7 

1,502,034,898 

35.0 

1,648,751,438 

35.2 

On  time, 

single  name 

paper  (one 

person  or 

firm)  with- 

out other 

security    .  .  . 

317,520,501 

15.5 

776,125,101 

18.0 

899,494,658 

19.2 

On  time, 

secured 

by  stocks, 

bonds,  and 

other  per- 

sonal securi- 

ties, or  on 

mortgages 

or  other 

real  estate 

security    .  .  . 

407,104,110 

19.8 

818,117,338 

19.0 

869,237,859 

18.6 

Total  

2,051,009,438 

4,298,893^16 

4,678,583,969 

LOANS  OF  THE  BANK  321 

399.  Demand  loans  have  increased. — The  first  class 
represents  the  demand  loans  of  all  the  national  banks. 
It  will  be  noted  that  these  unsecured  demand  loans  have 
increased  over  4  per  cent  in  ten  years. 

The  second  class  are  demand  loans  secured  by  stocks 
and  bonds  as  collateral.  There  is  an  increase  propor- 
tionately in  this  form  of  loans  between  1897  and  1906. 
The  year  1906  was  one  of  great  speculation  in  the  stock 
markets,  and  the  increase  in  this  item  represents  the 
growth  of  speculation  on  the  margins.  About  one- 
third  of  these  loans  are  reported  by  the  New  York  banks 
alone.  In  1897  these  loans  fell  off  proportionately  to 
others,  probably  on  account  of  the  liquidation  of  the 
stock  markets  which  had  taken  place  during  the  summer, 
the  margin  traders  having  been  sold  out  and  their  stocks 
going  into  the  hands  of  holders  who  could  purchase 
them  outright. 

400.  Double-name  paper. — The  next  item  represents 
trade  paper  discounted  at  the  banks.     The  decrease  of 
8  per  cent  in  ten  years  indicates  the  changing  nature  of 
bank  loans.     The   commercial  paper   placed   through 
commercial  paper  houses,  which  are  described  later,  is 
single-name  paper.     It  is  now  the  custom  of  the  largest 
houses  not  to  take  notes  from  their  customers  but  to 
borrow  on  their  own  credit.     This  tendency  is  more  ap- 
parent in  the  cities  than  in  the  country  as  a  whole. 
Throughout  the  country  there  has  been  an  absolute  in- 
crease in  two-name  paper  of  nearly  100  per  cent,  while 
the  increase  in  this  class  of  loans  held  by  New  York 
banks  has  been  not  more  than  30  per  cent. 

401.  Single-name  and  brokers'  paper. — The  amount 
of  single-name  paper  held  by  the  banks  has  almost  dou- 
bled in  ten  years,  indicating  the  growth  of  the  com- 
mercial paper  houses  and  the  decline  of  discounting. 

VII— 21 


322  MONEY  AND  BANKING 

The  last  classification  represents  time  loans  on  mort- 
gages or  other  security.  Since  the  law  prohibits  the 
national  banks  from  loaning  on  mortgages  the  collateral 
back  of  these  loans  is  probably  to  a  large  extent  personal 
securities  and  warehouse  receipts. 

Below  are  reproduced  two  forms  of  notes  in  use  gen- 
erally by  banks : 

JUDGMENT  NOTE 


$ EVANSTON,  ILL 189 

after  date,  for  value  received promise  to  pay 

to  the  order  of  the  STATE  BANK  OF  EVANSTON, 

DOLLARS, 

at  the  STATE  BANK  OF  EVANSTON,  with  interest  at  the  rate 

of per  cent  per  annum  from until  paid. 

W 

And  to  secure  the  payment  of  said  amount   hereby 


en 


fe 
O 

* 
£ 

< 
« 

w 

H 
< 

g 


authorize  irrevocably  any  attorney  of  any  Court  of  record  to  ap- 
pear for in  such  Court,  in  term  time  or  vacation,  at  any 

time  hereafter,  and  confess  a  judgment  without  process  in  favor 
of  the  holder  of  this  note,  for  such  amount  as  may  appear  to  be 
unpaid  thereon,  together  with  costs  and  dollars  attor- 
ney's fees,  and  to  waive  and  release  all  errors  which  may  intervene 
in  any  such  proceedings,  and  consent  to  immediate  execution  upon 

such  judgment;  hereby  ratifying  and  confirming  all  that 

said  attorney  may  do  by  virtue  hereof. 


No Due. 


COLLATERAL  NOTE 

$ EVANSTON,  ILL., 

ON  DEMAND,  after  date promise  to  pay  to  the  order  of  the 

STATE  BANK  OF  EVANSTON,  at  its  office, 

DOLLARS, 

for  value  received,  with  interest  at   the  rate  of   per  cent  per 

annum,  after  date,  having  deposited  with  said  Bank  as  collateral  security 
for  the  payment  of  this  and  any  other  liability  or  liabilities  of  the  under- 
signed to  said  Bank  heretofore  or  hereafter  contracted,  the  following  prop- 
erty, viz.: 


the  market  value  of  which  is  now  $ //  the  Bank  or  its  assigns 


LOANS  OF  THE  BANK  323 

shall  find  that  said  collateral  security  is  of  less  value  than  above  stated,  or 
any  of  said  security  shall  decline  in  value,  or  the  liability  of  the  under- 
signed to  said  Banks  or  its  assigns  shall  be  at  any  time  increased,  said  Bank 
or  its  assigns  may  call  for  additional  security  satisfactory  to  the  holder 
hereof,  and  failure  to  furnish  the  same  shall  make  this  note  at  once  due  and 
payable.  The  undersigned  hereby  gives  said  Bank,  its  attorney  or  its 
assigns,  full  power  to  sell  said  collateral  or  any  part  thereof,  without  notice 
or  demand,  at  public  or  private  sale,  in  case  said  collateral  shall  be  found 
of  less  value  than  above  stated,  or  in  case  any  of  said  collateral  shall  decline 
in  value,  or  in  case  additional  security,  satisfactory  to  the  holder  hereof,  shall 
not  be  furnished  upon  call  as  above  provided,  or  in  case  this  note  or  any 
other  liability  of  the  undersigned  to  said  Bank  shall  not  be  paid  at  ma- 
turity, and  if  such  sale  shall  be  public  or  at  Broker's  Board,  the  holder 
hereof  may  purchase  at  such  sale.  In  case  of  such  sale  the  proceeds,  after 
payment  of  the  costs  and  expenses  connected  with  said  collateral,  and  the 
sale  and  delivery  thereof,  may  be  applied  upon  any  liability  of  the  under- 
signed to  the  holder  hereof,  whether  due  or  not,  and  the  surplus,  if  any,  shall 
be  paid  to  the  undersigned,  his  or  their  assigns;  but  if  the  proceeds  of  such 
sale  shall  not  pay  in  full  the  liabilities  of  the  undersigned  to  the  holder 
hereof,  the  balance  of  such  liabilities  shall  become  at  once  due  and  pay- 
able and  bear  interest  at  the  rate  of  seven  per  cent  per  annum  from  the 
time  of  such  sale.  In  case  of  any  exchange,  or  addition  to  the  collateral 
above  named,  the  provisions  hereof  shall  extend  to  such  new  or  additional 
collateral.  In  case  of  the  insolvency  of  the  undersigned,  any  indebtedness 
due  from  the  legal  holder  hereof  to  the  undersigned  may  be  appropriated 
and  applied  hereon  at  any  time,  as  well  before  as  after  maturity  hereof. 

No 

Due 

402.  Judgment  note. — In   the   judgment   note   the 
signer  authorizes  the  bank  through  its  attorney  to  ap- 
pear in  any  court  and  get  judgment  in  the  amount  of 
the  note  without  the  trouble  and  expense  of  proving 
the  existence  of  the  debt  or  giving  the  signer  the  right 
to  defend  himself  against  the  judgment.     This  form  of 
note  enables  the  bank  to  become  a  judgment  creditor 
in  case  the  signer  is  threatened  with  insolvency  and  thus 
to  place  itself  in  a  preferred  position  in  collecting  the 
debt. 

403.  Collateral  note. — The  collateral  note  is  the  ordi- 
nary note  required  of  borrowers  who  pledge  collateral 
to  secure  the  debt.     It  will  be  noted  that  the  collateral 
deposited  secures  not  only  this  debt  but  any  other  debt 
that  the  signer  owes  to  the  bank.     The  bank  has  the 
right  at  any  time  to  demand  additional  collateral,  and 
failure  to  deposit  such  collateral  makes  the  note  due  at 


324  MONEY  AND  BANKING 

once.  The  bank  does  not  have  to  wait  until  the  matur- 
ity of  the  note  to  proceed  against  the  debtor.  Further- 
more, if  additional  collateral  is  not  forthcoming  the 
bank  has  the  right  to  sell  the  collateral  at  public  or 
private  sale  and  is  even  permitted  to  buy  it  in  itself  if 
it  cares  to  do  so.  If  the  sale  of  the  collateral  should 
fail  to  cover  the  indebtedness  the  balance  is  still  an  obli- 
gation against  the  debtor.  If  the  signer  should  become 
insolvent  the  bank  is  a  preferred  creditor  and  may  seize 
the  collateral. 

These  provisions,  which  seem  so  drastic,  are  necessary 
in  order  that  the  bank  may  protect  itself  in  times  of 
falling  values.  The  banks  making  collateral  loans  usu- 
ally depend  almost  entirely  upon  the  collateral  and  very 
little  upon  the  general  credit  of  the  borrower.  There 
have  been  numerous  cases,  however,  to  show  that  a  bank 
is  not  always  safe  in  relying  upon  the  value  of  the 
collateral.  Forged  securities  have  been  used  to  secure 
loans,  the  forgers  depending  upon  the  carelessness  of 
the  bank  in  not  scrutinizing  the  securities  as  carefully 
as  if  they  were  purchasing  them. 

404.  Risk  in  collateral  loans. — A  few  years  ago  a  new 
stock  of  the  Railway  Equipment  Company  appeared 
on  the  curb  market  in  New  York.  Being  in  the  hands 
of  the  promoters  of  the  company  the  stock  was  easily 
bid  up  to  a  very  high  price  by  means  of  "wash  sales"- 
that  is,  the  promoters  buying  and  selling  the  stock 
among  themselves.  After  the  public  had  become  accus- 
tomed to  seeing  the  quotations  of  the  stock  in  the  daily 
newspapers  the  promoters  went  to  other  cities  and 
opened  deposit  accounts  with  the  banks.  Having  estab- 
lished their  credit  they  persuaded  the  banks  to  accept  this 
stock  as  collateral  with  a  liberal  margin.  When  the  con- 
federates had  borrowed  as  much  as  they  could  the  banks 


LOANS  OF  THE  BANK  325 

were  one  day  surprised  and  chagrined  to  find  that  the 
price  of  the  stock  on  the  curb  market  had  fallen  to 
almost  nothing  and  that  the  collateral,  which  was  the 
only  security  for  the  loan,  was  almost  worthless. 

The  great  bulk  of  collateral  loans  in  Wall  Street  are 
call  or  demand  loans.  When  the  lender,  usually  a  bank 
or  trust  company,  calls  the  loan  the  borrower  must  pay 
it  or  his  collateral  is  sold  to  satisfy  the  debt.  The  rates 
for  call  money  depend  upon  demand  and  supply.  The 
greatest  market  for  it  is  the  New  York  Stock  Exchange 
where  it  is  offered  by  brokers  just  like  a  stock.  When 
it  is  plentiful,  call  rates  range  from  1  to  3  per  cent, 
and  money  is  easy ;  from  6  to  8  per  cent  is  firm,  and  when 
it  soars  beyond  that  rate  money  is  stringent.  In  times 
of  panic  the  rate  has  gone  past  100  per  cent. 

405  Usury  laws. — Any  rate  of  interest  higher  than 
that  fixed  by  law  is  usurious.  How  then  can  New  York 
bankers  and  money  brokers  charge  40  or  80  per  cent 
for  call  money? 

Before  explaining  how  this  is  possible  let  us  see  just 
what  is  meant  by  the  legal  and  maximum  rates  of  inter- 
est as  fixed  by  statute  in  most  states.  There  is  a  very 
wide  misconception  of  what  is  meant  by  the  legal  rate. 
Contrary  to  the  usual  impression  it  is  not  always  the 
highest  rate  that  can  be  charged  for  borrowed  money. 
Instead,  it  is,  for  example,  the  rate  that  the  court  would 
impose  if  a  judgment  to  collect  an  account  "with  inter- 
est" were  entered.  If  the  legal  rate  in  the  state  where 
the  judgment  was  entered  happened  to  be  6  per  cent, 
the  defendant  would  have  to  pay  6  per  cent.  The  max- 
imum legal  rate  is  the  highest  rate  that  can  be  charged 
for  money,  and  any  rate  above  the  maximum  is  usury. 

In  some  states,  as  for  example  in  New  York  and 
Pennsylvania,  the  legal  and  maximum  rates  are  the  same 


326  MONEY  AND  BANKING 

— 6  per  cent;  in  Alabama  both  rates  are  8  per  cent; 
in  Illinois  the  legal  rate  is  5  per  cent  and  the  maximum 
rate  7  per  cent;  in  Kansas  6  per  cent  and  10  per  cent 
respectively ;  in  Indiana  6  per  cent  is  the  legal  rate  and 
8  per  cent  the  maximum  rate. 

406.  Call  loans  exempted. — Although  the  maximum 
rate  in  New  York  State  is  6  per  cent,  the  Wall  Street 
bankers  can  charge  any  rate  of  interest  for  call  loans 
by  reason  of  a  section  of  the  state  banking  law  which 
says :     "Upon  advances  of  money  repayable  on  demand 
to  an  amount  not  less  than  five  thousand  dollars  made 
upon  warehouse  receipts,  bills  of  lading,  certificates  of 
stock  or  deposit,  bonds  and  other  negotiable  instruments 
pledged  as  collateral  security  for  such  repayment,  and 
any  bank  or  individual  banker  may  receive  or  contract 
to  receive  and  collect  as  compensation  for  making  such 
advance    any    sum    to    be    agreed    upon    in    writing 
by  the  parties  to  such  transactions."     Thus  the  banker 
can  charge  any  rate  for  call  money  for  sums  of  $5,000 
and  more  that  the  borrower  is  willing  to  pay.     With  a 
time  loan — a  loan  made  for  a  specified  period,  as  ninety 
days — the  rate  cannot  be  higher  than  the  maximum  rate. 

Most  people  believe  that  a  call  loan  is  for  one  or  two 
days  only.  Some  call  loans  run  forty  days  or  even  more. 
The  interest  on  it  changes  with  the  fluctuations  in  call 
money  rates;  the  interest  on  a  time  loan  remains  the 
same  during  the  life  of  the  loan. 

407.  Loans  on  open  book  accounts. — Some  bankers 
loan  funds  to  business  men  on  the  security  of  open  book 
accounts  of  their  customers  or  on  installment  contracts. 
This  business  is  strongly  discountenanced  by  the  more 
conservative  banks,  they  classing  bankers  who  engage 
in  it  with  pawnbrokers.     Bankers  who  do  this  business 
claim  that  it  is  exactly  the  same  as  the  old  business  of 


LOANS  OF  THE  BANK  327 

discounting  trade  paper.  They  argue  that  as  trade 
paper  is  now  no  longer  given  by  customers  to  the  same 
extent  as  formerly,  the  merchants  have  none  of  it  to  dis- 
count at  their  banks  and  therefore  it  is  permissible  for 
them  to  borrow  on  the  funds  due  them  from  customers, 
although  these  are  not  in  the  form  of  notes.  Conserva- 
tive bankers  on  the  other  hand  say  that  under  present 
conditions  of  banking  competition  any  business  man 
can  borrow  on  his  general  credit  all  the  bank  funds  he  is 
entitled  to  and  that  those  merchants  who  can  get  funds 
only  by  hypothecating  and  assigning  their  book  accounts 
are  undeserving  of  any  bank  credit  at  all. 

408.  Providing  temporary  capital. — The  financial 
manager  of  a  business  is  concerned  principally  with 
bridging  over  the  interval  between  the  purchase  of  ma- 
terials, etc.,  and  the  realization  of  the  value  of  the  out- 
put of  the  industry.  The  value  of  all  the  materials 
and  stock  represents  capital  which  must  be  contributed 
by  someone.  If  materials  can  be  bought  on  credit,  the 
seller  is  the  one  who  has  provided  that  capital  for  a  short 
time,  though  he  may  shift  this  burden  on  to  a  bank  by 
discounting  a  note  taken  in  payment  for  the  materials. 
The  buyer  of  the  materials  may  thus  partially  escape 
the  burden  of  providing  temporary  capital.  On  the 
other  hand  his  own  customers — the  purchasers  of  his 
finished  product — may  put  upon  him  the  necessity  of 
furnishing  capital  to  them  by  demanding  terms  of  from 
thirty  days  to  six  months.  In  most  cases  the  business 
man  will  find  he  is  able  to  shift  less  of  a  burden  upon 
concerns  from  whom  he  buys  than  that  he  is  compelled 
to  bear  on  behalf  of  his  own  customers.  When  collec- 
tions are  slow  this  extra  burden  is  correspondingly  in- 
creased. 

The  task  of  the  financial  manager,  therefore,  is  to 


328  MONEY  AND  BANKING 

get  through  the  assistance  of  banks  the  use  of  capital 
not  needed  by  its  owners.  Banks  act  as  agents  between 
the  owners  and  the  users  of  capital.  They  are  always 
ready  to  furnish  capital  to  any  one,  provided  the  bor- 
rower can  give  satisfactory  security  for  repayment. 
The  security  off ered  to  a  bank  may  be  either  the  gen- 
eral credit  of  the  firm,  based  upon  its  reputation  for 
prompt  payment;  the  possession  of  property  above  its 
liabilities ;  or  the  maintenance  of  a  certain  deposit  balance 
at  the  bank.  In  case  these  are  not  sufficient,  capital  may 
be  granted  on  collateral — some  form  of  property  hy- 
pothecated to  the  bank. 


CHAPTER  XXII 

LOANS  AGAINST  COLLATERAL 

'409.  Collateral  for  bank  loans. — The  form  of  collat- 
eral most  easily  handled  is  no  doubt  stocks  and  bonds 
extensively  dealt  in  on  the  Stock  Exchange  and  which 
are  marketable  on  a  moment's  notice.  Real  estate  and 
other  forms  of  permanently  invested  capital  are  bad 
collateral  for  a  bank  because  of  the  difficulty  of  realizing 
upon  them  quickly.  The  third  great  class  of  property 
which  may  be  used  for  collateral  is  merchandise  and  ma- 
terials representing  the  investment  of  that  form  of  cap- 
ital which  it  is  the  legitimate  function  of  banks  to 
provide.  If  the  calculations  of  the  owner  are  not  amiss, 
this  property  will  be  prepared  for  the  market  and  sold 
within  the  near  future,  so  that  it  embodies  the  best  qual- 
ity in  a  collateral  security  in  that  it  will  be  liquidated 
naturally  and  thus  provide  funds  with  which  to  repay 
the  debt. 

410.  Merchandise  as  collateral. — The  difficulties  met 
with  in  the  use  of  this  most  natural  form  of  collateral 
for  bank  loans  have  considerably  hindered  its  employ- 
ment as  such.  Merchandise  and  materials  cannot  be 
delivered  to  the  bank  as  in  the  case  of  stocks  and  bonds. 
If  they  are  left  in  the  possession  of  the  borrower  they 
may  disappear,  or  substitution  may  be  made,  or  they 
may  deteriorate  through  neglect.  These  risks  can  be 
avoided  only  by  placing  the  goods  in  the  possession  of 
a  third  party,  who  acts  as  trustee  for  all  concerned  and 

329 


330  MONEY  AND  BANKING 

who  is  required  by  law  to  conform  to  certain  rules 
which  make  fraud  and  loss  impossible. 

411.  Advantages  of  good  warehousing  laws. — It  is 
to  the  interest  of  both  the  banks  and  the  borrowers  that 
the  warehousing  system  should  be  so  regulated  that 
loans  can  be  negotiated  on  warehoused  merchandise  as 
easily  and  safely  as  possible.     In  a  great  number  of 
cases  of  financial  difficulty  on  the  part  of  merchants 
or  manufacturers,  the  source  of  the  trouble  lies  in  the 
investment  of  too  much  capital  in  merchandise  or  ma- 
terials which  cannot  be  sold  quickly  without  loss  because 
of  adverse  market  conditions.     The  goods  have  value 
but  time  is  required  to  realize  upon  it.     Bankruptcy 
may  be  imminent  unless  the  banks  consent  to  provide 
the  temporary  capital  to  carry  the  merchandise,  and 
their  doing  so  may  depend  upon  the  risk  involved  in 
loaning  upon  the  security  of  the  merchandise.     The 
value  of  a  warehousing  system,  regulated  by  law,  is 
measured  by  its  service  in  eliminating  the  risk  attend- 
ant upon  loans  on  merchandise. 

412.  Loans  on  merchandise  a  legitimate  function  of 
banks. — The    character    of   bank    loans   has    changed 
greatly  in  recent  years.     There  has  been  a  marked  de- 
cline in  the  amount  of  trade  paper  offered  for  discount 
and  competition  among  banks  has  compelled  them  to 
develop  new  fields. 

The  collateral  loan  is  one  of  these,  but  few  banks 
have  been  willing  to  accept  anything  except  stocks  and 
bonds  as  collateral — loaning  on  merchandise  is  still 
regarded  in  many  quarters  as  a  species  of  pawnbroking 
and  is  classed  with  loaning  on  book  accounts.  Never- 
theless loans  on  merchandise  conform  more  strictly  to 
banking  principles,  and  they  promote  the  industrial 
property  of  the  community  more  than  any  other  class 


LOANS  AGAINST  COLLATERAL  331 

of  loans  in  that  they  give  substantial  aid  to  legitimate 
commerce  in  marketable  goods,  which  is  the  basis  of 
all  business.  Anything  which  removes  obstruction  from 
the  free  passage  of  goods  through  all  the  processes 
from  raw  material  until  they  reach  the  consumer  rep- 
resents an  economic  gain.  All  other  business,  of  what- 
ever kind,  is  merely  auxiliary  to  this  fundamental 
productive  activity.  There  is  no  doubt  that  the  imme- 
diate future  will  see  a  gradual  elimination  of  the  uncer- 
tainties and  risks  incident  to  loans  on  merchandise  and 
a  development  of  this  branch  of  banking. 

413.  Statement  of  a  bank  president. — On  this  subject 
President  Nash,  of  the  Corn  Exchange  Bank  of  New 
York,  at  its  fiftieth  anniversary  banquet,  spoke  as  fol- 
lows: 

The  bank  has,  however,  made  two  important  contributions  to 
American  banking.  President  Dunham,  being  familiar  with  the 
grain  business,  introduced,  immediately  on  taking  office,  the  un- 
usual practice  among  banks  of  assisting  merchants  to  carry 
large  stocks  of  grain  and  merchandise  in  this  port,  by  making 
loans  on  that  class  of  collateral  when  represented  by  the  ware- 
house receipts  or  bills  of  lading.  It  subjected  us  at  the  start 
to  the  stigma  of  being  a  pawnbroker's  shop,  and  this  stigma 
was  freely  applied.  But  eventually  the  principle  of  advances 
on  merchandise  was  adopted  by  other  banks,  until  now  it  is  well- 
nigh  universal.  It  has  always  been  a  distinctive  part  of  our 
business.  Mr.  Dunham  used  to  say  that  wheat  and  cotton,  wool 
and  pork,  lard  and  coffee  were  as  good  as  gold,  and  he  was 
ready  to  give  gold  to  the  man  who  was  willing  to  pledge  these 
commodities  as  security  for  its  payment.  He,  however,  con- 
fined his  operations  to  the  great  staples  named,  because  the 
quality  and  the  price  were  less  subject  to  wide  variations,  and 
was  chary  of  general  merchandise,  where  the  differences  are 
much  more  marked,  and  to  a  non-dealer  somewhat  deceptive. 
This  preference  for  the  staples  has  not  prevented  us  from  going 


332  MONEY  AND  BANKING 

into  less  desirable  lines  of  business,  where  the  solidity  of  the 
borrower  has  outweighed  the  disadvantages  of  his  collateral,  and 
varied  and  sometimes  amusing  lists  of  merchandise  have  been  re- 
ported to  our  directors  for  their  approval. 

414.  Law  of  warehouse  receipts. — The  great  limita- 
tion to  the  use  of  merchandise  as  collateral  is  not  so  much 
in  stability  of  values  of  the  commodities  as  it  is  the  diffi- 
culty of  maintaining  intact  and  secure  the  collateral 
itself.     The  development  of  warehousing  and  the  use 
of  the  warehouse  receipt  under  such  legal  regulation  as 
to  guard  against  fraud  is  gradually  diminishing  the 
risk  of  merchandise  loans. 

415.  Uniform  law. — A  valuable  contribution  to  this 
end  has  been  the  drafting  of  an  "Act  to  make  uniform 
the  law  of  warehouse  receipts"  by  the  Commission  on 
[Uniform  State  Laws  in  1906.     The  success  of  the  Com- 
mission in  getting  its  uniform  law  of  negotiable  instru- 
ments adopted  in  twenty-eight  states  and  by  the  federal 
(government  makes  it  more  than  likely  that  this  new 
act  will  soon  become  a  law  in  all  the  states.     As  in  the 
law  of  negotiable  instruments,  the  warehouse  receipt 
law  aims  to  codify  existing  laws  as  far  as  possible. 
Whenever  anything  new  is  proposed,  it  will  invariably 
be  found  a  step  in  the  direction  of  promoting  the  busi- 
ness of  loaning  on  merchandise.     The  passage  of  such 
a  law  in  states  which  have  not  already  a  similar  one  is 
of  the  most  vital  interest  to  merchants  and  manufac- 
turers as  well  as  bankers.     It  will  hasten  the  time  when 
loans  will  be  made  as  readily  on  warehouse  receipts  for 
stored  goods  as  they  are  now  made  on  stocks  and  bonds. 

The  advantage  of  the  warehouse  receipt  is  that  it 
enables  the  goods  described  in  it  to  be  sold  or  pledged 
for  a  loan  of  money  by  the  mere  delivery  of  the  ware- 


LOANS  AGAINST  COLLATERAL  333 

house  receipt,  thus  avoiding  the  inconvenience  of  an 
actual  removal  or  delivery  of  the  property  itself.  In 
other  words,  the  warehouse  receipt  is  a  symbol  for  the 
property  described,  and  the  delivery  of  the  receipt  is  in 
law  a  delivery  of  the  possession  of  the  property. 

416.  Risk  involved  in  loans  on  warehouse  receipts. — 
The  danger  of  accepting  a  warehouse  receipt  as  collat- 
eral may  arise  from  an  insufficient  or  false  description 
of  the  property;  the  unfaithfulness  of  the  warehouse- 
man, who  may  misappropriate  the  property  committed 
to  his  keeping;  negligence  in  caring  for  it;  or  from 
carelessness  in  allowing  receipts  to  circulate  when  the 
property  behind  them  may  not  exist  or  may  be  subject 
to  liens.     In  all  these  cases  the  holder  of  the  receipt 
might  lose  his  claim  to  the  property  and  would  be  forced 
to  rely  upon  the  personal  responsibility  of  the  ware- 
houseman for  reimbursement  of  his  loss. 

417.  Under  the  present  law. — Under  the  present  law 
in  most  states  the  warehouseman  is  responsible  as  bailee 
for  the  safekeeping  of  the  goods.     He  is  bound  to  use 
ordinary  diligence  or  such  care  as  prudent  persons  usu- 
ally take  of  their  property.     He  is  not  liable  for  losses 
caused  by  fire,  flood,  insurrection,  or  public  enemies. 
If  he  is  guilty  of  no  neglect  he  is  not  responsible  for 
goods  stolen  even  by  his  own  employes. 

Persons  depositing  merchandise  with  a  warehouse- 
man are  obliged  to  trust  to  his  fidelity  and  diligence  in 
taking  due  care  of  their  property,  and  persons  dealing 
in  warehouse  receipts  are  in  the  same  position,  and  must 
also  trust  to  the  accuracy  of  the  warehouseman  in  de- 
scribing in  the  receipt  the  property  intrusted  to  him. 
If  the  warehouseman  misappropriates  the  property,  or 
fails  to  take  due  care  of  it ;  if  he  falsely  or  insufficiently 


334  MONEY  AND  BANKING 

describes  it  in  the  receipt,  the  holder  of  the  receipt  may 
lose  his  claim  to  the  property  and  may  have  only  an 
action  for  damages  against  the  warehouseman. 

418.  Issue  of  receipts  safeguarded. — The  proposed 
act  throws  definite  restrictions  around  the  issuing  of 
receipts,  and  makes  the  warehouseman  criminally  liable 
in  many  cases.     It  provides  that  all  liens  on  the  goods 
must  be  set  forth  in  the  receipt,  including  the  rate  of 
storage  charges.     The  warehouseman  may  not  insert 
any  clause  absolving  himself  from  his  legal  liability  for 
due  care.     Duplicate  and  non-negotiable  receipts  must 
be  plainly  marked  as  such.     The  warehouseman  shall 
be  obliged  to  deliver  the  goods  on  the  receipt  if  the 
demand  is  accompanied  by  an  offer  to  satisfy  the  ware- 
houseman's lien,  a  surrender  of  the  receipt,  and  an 
acknowledgment  of  delivery.     The  warehouseman  shall 
be  justified  in  delivering  the  goods  to  any  one  tendering 
the  receipt  properly  endorsed.     If  a  thief  presented  a 
negotiable  receipt  properly  endorsed  the  warehouseman 
would  be  protected  if  he  delivered  the  goods  innocently. 

419.  Protection  to  holders  of  receipts. — If  the  ware- 
houseman shall  fail  to  take  up  and  cancel  a  negotiable 
receipt  when  goods  are  delivered,  he  shall  be  liable  for 
failure  to  deliver  the  goods  to  any  one  who  purchases 
for  value  in  good  faith  such  receipt,  whether  such  pur- 
chaser acquired  title  to  the  receipt  before  or  after  the 
delivery  of  the  goods  by  this  warehouseman. 

A  warehouseman  shall  be  liable  to  the  holder  of  a 
receipt  for  damages  caused  by  the  non-existence  of  the 
goods  or  by  the  failure  of  the  goods  to  correspond  to 
the  description  thereof  in  the  receipt  at  the  time  of  its 
issue.  If,  however,  the  goods  are  described  in  a  receipt 
merely  by  a  statement  that  they  are  said  to  be  goods  of 
a  certain  kind,  or  that  packages  containing  the  goods 


LOANS  AGAINST  COLLATERAL  335 

are  said  to  contain  goods  of  a  certain  kind,  or  by  words 
of  like  import,  such  statements,  if  true,  shall  not  make 
liable  the  warehouseman  issuing  the  receipt,  although 
the  goods  are  not  of  the  kind  which  the  marks  or  labels 
upon  them  indicate,  or  of  the  kind  they  were  said  to  be 
by  the  depositor.  This  makes  the  warehouseman  liable 
for  what  he  asserts  only. 

420.  Garnishment  not  allowed. — Goods  delivered  to 
a  warehouseman  who  issues  a  negotiable  receipt  there- 
for cannot  thereafter,  while  in  possession  of  the  ware- 
houseman, be  attached  by  garnishment  or  otherwise,  or 
be  levied  upon  under  an  execution,  unless  the  receipt  be 
first  surrendered  to  the  warehouseman  or  its  negotiation 
enjoined.     In  most  states  the  present  laws  disallow  any 
garnishment;  it  was  thought  best  in  this  act  not  to  take 
so  extreme  a  position  but  to  cover  the  essential  practical 
point  by  making  it  a  condition  of  the  validity  of  such 
seizure  that  the  negotiation  of  the  receipt  be  enjoined 
or  the  document  impounded. 

A  person  to  whom  a  negotiable  receipt  has  been  nego- 
tiated acquires,  according  to  the  act,  such  title  to  the 
goods  as  the  person  negotiating  it  had,  and  also  the 
direct  obligation  of  the  warehouseman  to  hold  possession 
of  the  goods  for  him  according  to  the  terms  of  the  receipt 
as  fully  as  if  the  warehouseman  had  contracted  directly 
with  him. 

421.  Penalty  for  illegal  use  of  receipts. — It  shall  be 
a  criminal  offense  for  a  warehouseman  to  issue  a  receipt 
for  goods  not  actually  received,  or  to  issue  a  receipt 
knowing  that  it  contains  a  false  statement,  or  to  issue 
duplicate  receipts  not  so  marked,  or  to  issue  a  receipt 
for  goods  of  which  he  himself  is  the  owner  without  stat- 
ing that  fact,  or  to  deliver  goods  without  canceling 
the  receipt.    Any  person  who  deposits  goods  to  which 


336  MONEY  AND  BANKING 

he  has  no  title,  or  upon  which  there  is  a  lien  or  mort- 
gage, and  takes  a  negotiable  receipt  therefor  with  intent 
to  deceive  without  disclosing  want  of  title,  shall  be  guilty 
of  a  crime. 

Loans  may  be  made  on  receipts  under  such  a  law  with 
little  risk  or  inconvenience  to  the  lender.  If  the  goods 
are  insured  his  chances  of  loss  are  practically  limited  to 
deterioration  in  the  quality  or  value  of  the  goods.  Sea- 
sonable goods  in  cold  storage,  such  as  fruit,  butter,  eggs, 
poultry,  etc.,  must  be  sold  at  certain  seasons,  lest  they 
shrink  in  value  by  having  to  compete  in  the  market  with 
fresh  goods  at  cheaper  prices. 

422.  Transfer  of  title  to  lender. — Many  banks  prefer 
not  to  accept  receipts  for  warehoused  goods  as  collateral 
at  all  but  require  the  transfer  on  the  books  of  the  ware- 
house to  themselves,  taking  a  non-negotiable  receipt 
therefor. 


CHAPTER  XXIII 

CREDIT  DEPARTMENT  OF  A  BANK 

423.  Credit  department  of  a  bank. — It  is  only  within 
recent  years  that  credit  departments  have  appeared  in 
the  banks.     Formerly  the  cashier  was  supposed  to  keep 
personally  all  the  credit  information.     However,  it  has 
been  found  preferable  by  the  banks  to  employ  a  compe- 
tent credit  man,  whose  sole  business  is  to  accumulate 
information  on  credits.     In  some  of  the  larger  city 
banks  and  especially  in  the  offices  of  a  commercial  paper 
house,  there  are  highly  organized  systematic  credit  bu- 
reaus, which  have  on  file  every  bit  of  information  regard- 
ing the  credit  standing  of  their  customers. 

424.  Sources  of  credit  information. — The  chief  source 
of  information  on  credits  is  of  course  the  statements  of 
the  customers  themselves.     Until  within  the  last  few 
years  it  was  not  the  custom  of  the  banks  to  demand  writ- 
ten statements  from  customers  and  there  are  still  business 
men  who  resent  the  request  of  banks  for  statements. 
As  a  rule,  however,  the  borrowers  have  found  it  to  their 
advantage  to  make  a  full  statement  of  their  affairs  to 
their  banker,  knowing  that  failure  to  make  such  a  state- 
ment will  prejudice  their  credit. 

A  standard  form  of  customers*  statement  in  use  by 
banks  is  reproduced  below  for  the  purpose  of  showing 
the  items  of  information  which  the  banks  believe  to  be 
important  in  the  granting  of  loans.  In  some  doubtful 
cases  the  banks  may  require  the  statement  to  be  certified 

by  a  professional  accountant. 
vii-22  337 


338 


MONEY  AND  BANKING 


Form  A. 

STANDARD    FORM    OF    STATEMENT    FOR    FIRMS    AS    ADOPTED    BY    NEW 
YORK    STATE    BANKERS    ASSOCIATION. 

FROM     

ADDRESS    

TO 

For  the  purpose  of  procuring  credit  from  time  to  time  with  you  for  our  nego- 
tiable paper  or  otherwise,  we  furnish  the  following  as  a  true  and  accurate  state- 
ment of  our  financial  condition  on  190..,  which  you  are  to  consider 

as  continuing  to  be  full  and  accurate  until  we  give  you  written  notice  of  change. 


ASSETS. 


Cash  on  hand 

Cash  in  the  following  banks 

ffame  of  bank    


Notes  Receivable  of  custo- 
mers (not  transferred) 

Accounts  Receivable  of  custo- 
mers (not  transferred) 

Notes  and  Accounts  Receiva- 
ble of  partners  (not  trans- 
ferred) 

Merchandise  finished  (how 
valued  ) 

Merchandise  unfinished  (how 
valued  • ) 

Merchandise  raw  material 
(how  valued  ) 

Land  owned  by  firm,  used 
for  this  business 

Buildings  ow_ned  by  firm, 
used  for  this  business 

Machinery  owned  by  firm, 
used  for  this  business 


TOTAL 


LIABILITIES. 


Notes  Payable  given  for  mer 

chandise 
Notes    Payable    negotiated    to 

own  banks 
Notes   Payable   otherwise   dis 

posed  of 

Accounts  Payable 

Deposits   of   Money   with   Us 

as  follows 

By * 

By * 


By $ 

By  sundry  persona  $. 


Mortgage   Debt    . . 
Chattel  Mortgages 


Total    Liabilities 


Net  Worth 


TOTAL 


CONTINGENT  LIABILITY:  Notes  Receivable  of  customers  Discounted 
or  Sold  and  not  included  in  assets  enu- 
merated above 

Other  contingent  liability    

We  Have  Not  Pledged  or  Assigned  any  of  the  above  Accounts  Receiva- 
ble ;  our  Assigned  Accounts  Receivable 
amount  to 

Other  assets  used  as  collateral 

INSURANCE:  on  merchandise   $ buildings $ machin- 
ery $ Total  Insurance 

BUSINESS  and  RESULTS:    Annual    Sales    for    the    year   ended 

190.  .or    from 190.  .to 190. . 

Gross  Profits  on   Sales 
Expense    of    Conducting    Business 
Net  Profit 
Other  Income,  including  investments 
Combined  Profit 

WITHDRAWALS  by  PARTNERS   (not  included  in  expense  of  conduct- 
ing   business)     from 190.  .to 190. . 

BAD  DEBTS  for  the  period  from 190.  .to 190.  . 

SPECIAL   CAPITAL:    contributed  by until 190.  . 

<f..  .    "  ..190.. 


For  the  same  period 


.190. 


GENERAL    PARTNERS:    n  me Outside  Net  Worth 


CREDIT  DEPARTMENT  OF  A  BANK          339 

BANK  ACCOUNTS :  where  kept  other  than  above  

MORTGAGES :  on  what  assets  a  lien 

Average  TERMS  on  which  we  SELL  

Average  TERMS  on  which  we  BUY 

DATE  of  ORGANIZATION  and  EXPIRATION  of  PARTNERSHIP  

TIME  of  YEAR  when  Notes  and  Accounts  Receivable  of  customers,  Uncollected, 

are  generally  maximum  minimum 

TIME  OF  YEAR  when  Stocks  of  Merchandise  on  hand  are  generally  maximum 

minimum  

TIME  of  YEAR  when  Liabilities  are  maximum  minimum 

STATEMENT:  is  it  based  on  actual  inventory? if  so,  Date 

VERIFICATION:  have  the  books  been  audited  by  a  Certified  Public  Accountant! 

if  so,  Name  and  Date  of  Audit 

BUSINESS:  what  kind  of  business  do  you  conduct?    

BOOKS :  what  kind  of  books  do  you  keep  ?   


(Please   sign   firm   name) 

Date    Signed 190..  By. 

Please  Give  Particulars  of  Each  Parcel  of  Real  Estate 


Description 

Street   and 
number 

City    or    town 
and   state 

Title  in 
name  of 

Estimated 
value 

Mort- 
gages 

Equity 

The  law  is  still  uncertain  toward  persons  who  make 
false  statements  for  the  purpose  of  gaining  credit.  The 
notorious  failure  of  A.  Booth  and  Company  of  Chicago 
in  1908  induced  the  legislature  of  Illinois  to  pass  a  law 
in  1909  making  it  a  criminal  offense  to  obtain  loans 
on  false  or  misleading  statements.  The  penalty  for 
doing  so  is  fine  and  imprisonment. 

425.  Credit  agencies. — The  second  source  of  informa- 
tion is  the  credit  agencies.  The  chief  credit  agencies  in 
this  country  are  Dun's  and  Bradstreet's.  Concerning 
the  function  of  these  agencies  one  banker  has  said: 
"Any  man  is  unwise  to  base  a  $50  credit  solely  on  an 


340  MONEY  AND  BANKING 

agency  rating  or  report,  but  any  man,  business  house 
or  institution  is  doubly  unwise  who  cannot  get  back  in 
full  all  that  he  pays  out  to  the  commercial  agency,  pro- 
vided he  knows  how  to  use  the  information  which  he 


receives." 


The  fact  that  the  agencies  charge  the  same  fee  for 
reporting  upon  a  credit  involving  $50,000  as  they  do 
upon  a  credit  involving  only  $5,  makes  it  impossible  for 
them  to  do  more  than  superficial  work.  The  reports 
are  obtained  by  reporters  who  are  not  expert  credit  men, 
and  who  are  required  furthermore  to  report  upon  ten  to 
fifty  concerns  in  one  day.  The  reporter  will  first  try  to 
get  a  statement  from  the  concern  under  investigation, 
and  then  will  go  to  the  banker  or  local  lawyer  for  infor- 
mation. The  maximum  salary  of  the  bulk  of  such  re- 
porters is  not  much  above  $20  per  week.  The  business 
is  very  profitable,  in  the  case  of  Bradstreet's  paying  a 
profit  of  &y2  per  cent  on  its  capital  of  $1,500,000.  The 
charge  for  the  service  of  an  agency  is  $100  a  year.  This 
sum  entitles  the  subscriber  to  100  special  reports  and  a 
book  of  ratings  semi-annually.  The  reports  are  valu- 
able in  suggesting  points  which  might  otherwise  be  over- 
looked and  in  tabulating  information  obtained  in  other 
ways. 

426.  Duties  of  credit  man. — It  is  the  business  of  the 
credit  man  to  cultivate  every  possible  source  of  informa- 
tion bearing  on  credits.  He  must  consult  court  records 
to  find  suits  which  have  been  filed  or  judgments  ren- 
dered. He  must  know  when  any  of  his  clients  have 
recorded  mortgages.  He  should  find  out  the  business 
affiliation  of  his  clients  so  as  to  get  clues  as  to  the  kind 
of  business  done  by  them. 

The  credit  department  of  a  bank  affords  the  best  op- 
portunity of  any  department  for  the  young  man  who 


wishes  to  learn  the  banking  business.  The  experience 
of  getting  information  about  the  business  men  of  the 
community  and  about  the  peculiar  conditions  existing 
in  the  various  lines  of  trade,  will  cultivate  in  him  the 
power  of  judgment  so  that  by  actual  practice  in  the 
subordinate  position  he  may  qualify  himself  for  the  desk 
of  an  officer.  This  can  scarcely  be  said  of  any  other 
subordinate  position  in  a  bank. 

427.  The  commercial  note-broker. — The  note-broker 
is  a  middle-man  between  the  lending  bank  and  the  bor- 
rowing business  man.     His   profession  is  to   borrow 
money  for  other  people,  and  the  need  for  his  services 
and  the  amount  of  his  remuneration  will  depend  upon 
his  skill  in  placing  loans  and  in  obtaining  favorable 
terms   from   the  lenders.     To  borrow   money  to   the 
best  advantage  is  an  art  requiring  expert  knowledge 
and  ability  beyond  that  of  the  average  business  mana- 
ger, and  if  his  borrowings  are  large  enough  to  make 
it  worth  while  it  is  profitable  for  him  to  engage  the 
services  of  the  note-broker  in  this  business. 

The  business  of  note-broking  has  changed  radically 
within  the  last  decade  and  is  still  in  the  process  of  rapid 
development.  The  old-fashioned  broker  was  simply  an 
agent  who,  for  a  certain  commission,  placed  the  promis- 
sory notes  of  his  principal  at  the  lowest  rate  of  discount 
he  could  obtain.  He  incurred  no  liability,  had  no  occa- 
sion to  employ  capital  of  his  own,  and  did  not  attempt 
to  place  the  paper  far  from  the  locality  of  its  inception. 

428.  Change  in  the  business. — The  note-broker  on 
commission  has  given  place  to  the  dealer  in  commercial 
paper  who  buys  and  sells  outright  the  promissory  notes 
of  his  clients.     The  business  is  practically  controlled 
by  seven  or  eight  large  firms  whose  operations  extend 
over  a  large  part  of  the  whole  country.     The  nature  of 


342  MONEY  AND  BANKING 

the  business  is  such  that  the  tendency  toward  centraliza- 
tion in  a  few  strong  hands  is  inevitable  because  of  the 
disadvantages  under  which  the  small  operator  must 
labor.  Large  capital,  the  confidence  of  lenders,  a 
thoroughgoing  and  efficient  credit  department  which 
is  necessarily  expensive,  and  a  large  staff  of  salesmen, 
are  factors  against  which  the  small  broker  finds  it  im- 
possible to  compete. 

In  order  to  buy  and  sell  paper  to  the  best  advantage, 
the  modern  note-broker,  or  more  properly  the  dealer  in 
commercial  paper,  must  have  a  capital  approximating 
$1,000,000.  His  clients  demand  the  money  upon  their 
notes  at  once  and  the  notes  must  be  held  several  days 
before  they  can  be  realized  upon.  With  such  a  capital 
our  typical  dealer  in  commercial  paper  can  do  an  annual 
business  of  $100,000,000  at  an  expense  of  about  $100,- 
000,  or  one-tenth  of  1  per  cent.  He  can  make  a  good 
profit  if  he  can  get  one-fourth  of  1  per  cent  or  even 
less  margin  on  the  paper  he  handles. 

429.  Demand  and  supply  of  commercial  paper. — In 
times  when  the  demand  for  loanable  funds  is  great  and 
the  interest  rate  high,  the  dealer  has  no  difficulty  in 
purchasing  first-class  paper.  He  does  not  need  to  seek 
out  new  clients  but  on  the  contrary  is  kept  busy  market- 
ing the  paper  of  his  old  clients.  The  energies  of  the 
dealer  are  directed  almost  entirely  to  selling.  The 
house  with  a  well-organized  and  efficient  selling  force 
has  a  great  advantage  over  competitors.  The  firm  here 
in  mind  has  twenty  salesmen  covering  nearly  the  whole 
of  the  United  States.  Through  these  agents  it  is  en- 
abled to  keep  informed  on  the  money  situation  of 
section. 

The  rate  of  interest  in  any  locality  is  determined  by 
the  demand  for  and  the  supply  of  loanable  funds.  The 


CREDIT  DEPARTMENT  OF  A  BANK          348 

forces  vary  from  time  to  time  with  more  or  less  reg- 
ularity. While  the  cotton  crop  is  being  marketed  in 
the  South,  for  instance,  the  demand  for  funds  is  very 
great  and  beyond  the  available  supply.  Late  in  the 
year,  when  the  money  returns  to  the  banks,  the  supply 
of  loanable  capital  may  far  exceed  the  demand  and  very 
low  rates  of  interest  may  prevail.  There  is  scarcely 
any  locality  which  is  not  subject  to  these  seasonal 
fluctuations  as  well  as  the  accidental  fluctuations  which 
may  occur  at  any  time. 

430.  Areas  of  high  and  low  rates. — The  monetary 
conditions  of  the  whole  country  might  be  represented 
in  much  the  same  way  as  the  weather  conditions  on  the 
weather  map — there  are  areas  of  high  money  and  areas 
of  low  money,  and  these  "highs"  and  "lows"  move  across 
the  map  with  more  or  less  regularity.     Being  able  to 
predict  the  movement  of  the  "lows,"  the  expert  dealer 
in  commercial  paper  is  able  to  take  advantage  of  low 
interest  rates  wherever  he  finds  them,  while  the  borrower 
himself  is  confined  to  his  own  immediate  locality  where 
the  rate  most  of  the  time  may  be  higher  than  the  "low" 
in  some  other  section. 

Owing  to  his  ability  to  sell  paper  at  a  lower  rate  of 
discount  than  the  borrower  himself,  the  dealer  may  re- 
alize a  handsome  profit  while  discounting  at  the  same 
rate  as  the  local  banks.  As  far  as  the  rate  is  concerned, 
the  borrower  may  just  as  well  patronize  the  dealer  as 
the  banks.  There  are,  however,  four  additional  induce- 
ments which  the  dealer  may  offer. 

431.  Discount  offer  by  dealer. —  (1)   It  is  an  almost 
universal  rule  of  the  banks  to  require  that  the  borrower 
shall  maintain  a  deposit  balance  equal  to  at  least  20  per 
cent  of  his  loan.     This  means  that  the  borrower  can 
actually  use  but  $80  out  of  every  $100  borrowed  from 


344  MONEY  AND  BANKING 

the  bank.  If  he  has  borrowed  at  the  rate  of  5  per  cent 
interest,  he  actually  pays  over  6  per  cent  for  every  avail- 
able $100.  If  he  sold  his  paper  to  a  dealer  he  would 
realize  at  once  the  full  face  value  of  the  loan. 

(2)  By  selling  his  paper  through  a  dealer  he  keeps 
his  credit  at  his  bank  open  and  unimpaired,  so  that  in 
case  of  emergency  he  has  this  resource  to  fall  back  upon. 

(3)  By  establishing  relations  with  a  dealer  he  creates 
a  broader  market  for  his  paper  and  may  reasonably 
expect  the  dealer  to  favor  him  as  an  old  customer  when 
otherwise  he  could  not  get  accommodation,  perhaps  be- 
cause of  a  stringent  money  market  or  because  his  credit 
showing  was  not  satisfactory  to  those  with  whom  he  had 
no  previous  dealings. 

(4)  The  dealer  has  facilities  for  floating  a  much 
larger  loan  than  any  bank  could  handle,  thus  relieving 
a  large  borrower  of  the  necessity  of  negotiating  with 
several  parties. 

Dealers  in  commercial  paper  do  not  endorse  the  notes 
they  sell,  nor  do  they  assume  any  liability  except  for 
their  genuineness.  The  notes  are  made  payable  to  the 
maker  so  that  they  may  be  negotiated  without  endorse- 
ment. The  success  of  a  dealer  is  so  closely  dependent 
upon  his  reputation  for  handling  only  good  paper  that 
he  will  use  every  effort  to  protect  the  holder  against 
loss ;  so  there  is  practically  little  risk  in  buying  his  paper. 
In  case  of  a  failure  the  dealer  will  take  charge  of  the 
claims  of  his  customers,  and  as  this  usually  makes  him 
the  largest  creditor  he  will  be  able  to  prevent  undue 
loss  by  reason  of  unskillful  handling  of  assets  of  the 
failed  firm. 

432.  'Credits. — The  best  guarantee  against  loss  fur- 
nished by  the  dealer  is  the  close  attention  given  by  the 
credit  department  to  every  note  sold.  The  most  effi- 


CREDIT  DEPARTMENT  OF  A  BANK 


345 


cient  credit  departments  in  the  country  are  those  main- 
tained by  the  dealers  in  commercial  paper.  No  client 
is  taken  until  his  financial  condition  has  withstood  a  most 
searching  investigation.  A  statement  is  always  re- 
quired and  must  be  revised  at  frequent  intervals.  Each 
salesman  has  copies  of  these  statements  to  show  to  pros- 
pective customers.  Under  ordinary  circumstances  no 
paper  will  be  bought  by  the  dealer  unless  the  statement 
of  the  maker  shows  quick  assets  (cash,  merchandise, 
and  bills  receivable)  of  at  least  twice  the  value  of  the 
liabilities.  The  credit  department  may  be  regarded  as 
the  most  vital  part  of  the  business  of  dealing  in  com- 
mercial paper.  Few  banks  outside  the  largest  cities 
have  credit  facilities  and  they  are  disposed  to  rely  more 
and  more  on  the  information  furnished  by  the  note 
dealer  as  experience  proves  its  reliability  to  them. 

433.  Size  of  notes. — The  notes  sold  are  usually  di- 
vided into  amounts  of  $5,000  each  and  rarely  run  longer 
than  six  months,  the  average  being  about  ninety  days. 
Prices  are  quoted  in  per  cent,  the  higher  the  rate  of  dis- 
count the  lower  the  price  of  the  note.  For  example, 
a  note  for  $5,000  due  in  six  months  without  interest  may 
be  bought  by  the  dealer  for  6  per  cent,  which  means  that 
it  would  yield  to  the  borrower  $5,000  less  the  interest 
on  $5,000  at  6  per  cent  for  six  months  ($150) .  The  net 
yield  would  be,  therefore,  $5,000  minus  $150,  or  $4,850. 
If  the  dealer  sold  it  immediately  to  a  bank  at  5^  per 
cent  for  six  months  (or  whatever  time  remained  until 
the  note  was  due  in  case  the  dealer  had  held  it  for  a 
while),  this  would  amount  to  $4,862.50  ($5,000  less 
$137.50) .  The  profit  to  the  dealer  would  be  the  differ- 
ence between  $4,862.50  and  $4,850,  or  $12.50. 

The  business  of  dealing  in  commercial  paper  and  dis- 
tributing it  throughout  the  country  on  a  large  scale 


346  MONEY  AND  BANKING 

is  so  recent  and  is  developing  so  rapidly  that  the  total 
effect  on  the  banking  situation  has  not  been  fully  worked 
out.  An  inevitable  tendency  will  be  to  equalize  the 
rate  of  interest  throughout  the  country;  the  smallest 
country  bank  will  have  loaning  f  acilities  almost  as  good 
as  the  largest  city  bank.  There  will  be  no  inducement 
for  it  to  deposit  its  surplus  funds  in  New  York  at  1  or 
2  per  cent  interest  when  it  can  buy  first  class  paper 
at  much  higher  rates.  On  the  other  hand,  business 
firms  who  are  large  borrowers  will  have  a  market  for 
their  paper  as  wide  as  the  whole  United  States  and  will 
thus  be  emancipated  from  local  restrictions. 


CHAPTER  XXIV 

HISTORY  OF  BANKING  IN  THE  UNITED  STATES 

434.  Characteristics   of  early   banking. — The   early 
history  of  banking  in  the  United  States  is  for  the  most 
part  a  history  of  the  issue  of  circulating  notes.     Prior 
to  the  national  bank  act  of  1865  which  greatly  restricted 
note  issue,  the  deposit  currency  represented  but  a  small 
proportion  of  the  circulating  medium  of  the  country 
and  hence  occupied  a  relatively  unimportant  place  in 
the  business  of  banking.     Particular  attention  must  be 
given,  therefore,  in  a  discussion  of  banking  prior  to 
1865,  to  the  success  and  failure  of  the  various  plans  for 
issuing  notes. 

435.  Relations  with  government. — Another  function 
of  early  banking,  however,  was  to  facilitate  fiscal  op- 
erations of  both    the  federal  and  state  governments. 
Although  this  has  continued  to  be  a  banking  func- 
tion to  the  present  day,  its  early  history  plainly  shows 
that  it  is  not  a  safe  one,  however  efficient  it  may 
seem;  and  there  is  a  marked  tendency  toward  the  com- 
plete divorcement  of  banking  from  financing  govern- 
ment   expenditures.     This    divorcement    has    already 
taken  place  in  the  operations  of  the  states,  and  remains 
in  the  operations  of  the  federal  government  only  in 
the   requirement   that   bank   notes    be    secured    by   a 
deposit  of  government  bonds  with  the  Treasury,  a  re- 
quirement which  creates  a  fictitious  demand  for  bonds 
and  so  lowers  the  interest  rate  that  there  is  practically 
no  demand  for  them  except  from  the  banks.     In  this 

347 


348  MONEY  AND  BANKING 

way  it  is  still  a  function  of  banking  to  finance  govern- 
ment loans. 

436.  Historical  periods. — The  history  of  banking  in 
this  country  may  be  divided  into  four  periods:     (1) 
First  bank  of  the  United  States;  (2)  Second  Bank  of 
the  United  States;  (3)  state  banking,  and  (4)  national 
banking.     In  point  of  time  these  periods  are  not  at 
all  distinct  because  they  overlap,  but  there  was  a  period 
in  which  each  was  the  most  important  development  in 
banking. 

437.  Some  early  banks. — Prior  to  the  establishment 
of  the  First  Bank  of  the  United  States  several  banks 
existed  which  are  worthy  of  note.     The  first  one  estab- 
lished was  the  Bank  of  North  America  in  Philadelphia, 
chartered  by  Congress  in  1781.     It  was  capitalized  at 
$400,000;  $250,000  being  subscribed  by  the  government. 
Considerable  doubt  existed  as  to  the  powers  of  Congress 
in  chartering  a  bank,  hence  in  1782  a  charter  was  ob- 
tained from  the  State  of  Pennsylvania.     During  the 
years  of  financial  chaos  that  followed,  the  bank  per- 
formed an  inestimable  service  by  making  large  loans 
to  the  government  for  the  maintenance  of  the  army. 
In  spite  of  this  service  the  bank  was  severely  attacked 
after  the  close  of  the  war,  and  for  several  years  had 
an  extremely  precarious  existence;  it  was  finally  re- 
chartered  by  the  State  of  Pennsylvania,  under  which 
charter  it  prospered  until  it  became  a  national  bank 
in  1865. 

The  Bank  of  Massachusetts,  with  a  capital  of  $300,- 
000,  was  chartered  by  the  State  of  Massachusetts  in 
1784.  In  the  same  year  the  Bank  of  New  York  was 
established  by  Alexander  Hamilton.  For  several  years 
it  existed  as  a  private  bank  but  was  finally  chartered 
by  the  legislature  in  1791.  In  both  states  an  attempt 


HISTORY  OF  BANKING  349 

was  made  to  regulate  banking  in  the  interest  of  the 
public  welfare,  and  as  some  of  the  problems  which  the 
legislature  attacked  are  still  with  us  their  consideration 
is  interesting. 

The  most  important  restriction  dealt  with  the  issue 
of  notes.  In  Massachusetts  it  was  provided  that  the 
outstanding  loans  and  notes  or  credits  and  debts  (ex- 
cept to  depositors)  should  not  amount  to  more  than 
twice  the  paid-in  capital;  in  New  York,  the  debts  of 
the  bank,  over  and  above  the  money  then  actually  de- 
posited in  the  bank,  were  not  to  amount  to  more  than 
three  times  the  paid-in  capital.  Thus  a  distinction  was 
made  between  the  liability  of  a  bank  to  its  note  holders 
and  to  its  depositors;  and  there  is  no  doubt  of  the  ex- 
istence of  a  reason  for  this  distinction  at  that  time. 
The  deposit  currency  was  not  developed,  and  when  bor- 
rowers appeared  they  wanted  notes  which  they  could 
use  as  money.  Deposits  were  not  created,  therefore,  by 
loaning  as  they  are  to-day,  but  entirely  by  the  actual 
deposit  of  money,  a  process  which  did  not  in  any  way 
increase  the  proportion  between  the  bank's  demand  obli- 
gations and  its  unmatured  assets.  The  deposit  account 
was  exchanged  for  money,  whereas  the  bank  note  was  ex- 
changed for  unmatured  credit. 

Both  banks  were  prohibited  from  dealing  in  merchan- 
dise, and  the  Bank  of  New  York  from  trading  in  the 
stocks  of  the  United  States  or  any  of  the  states.  This 
was  evidently  an  attempt  to  separate  banking  and  gov- 
ernment and,  as  such,  was  a  correct  principle. 

438.  Loaning  on  bank  stock. — The  Bank  of  Massa- 
chusetts was  prohibited  from  dealing  in  bank  stocks, 
another  provision  which  was  fundamentally  sound. 
The  practice  of  dealing  in,  or  rather  loaning  on,  bank 
stocks  has  many  dangers,  as  was  amply  proved  in  the 


350  MONEY  AND  BANKING 

panic  of  1907.  It  enables  unscrupulous  financiers  to 
buy  one  bank,  deposit  their  stock  with  it  as  collateral 
for  a  loan,  and  with  the  proceeds  of  the  loan  to  purchase 
the  controlling  stock  in  another  bank.  This  operation 
may  be  continued  until  a  number  of  banks  are  under 
the  same  ownership,  the  benefit  to  the  financier  arising 
from  the  fact  that  he  obtains  control  and  consequently 
increased  credit  from  them  all.  Its  danger  is  due  to 
the  fact  that  any  calamity  which  affects  one  bank  must 
affect  them  all.  The  Bank  of  New  York  was  restricted 
from  loaning  on  real  estate,  or  holding  it  except  for 
banking  purposes  or  when  it  came  into  its  possession 
in  settlement  for  debts  previously  contracted.  This  was 
likewise  an  able  provision  and  one  which  is  found  in 
practically  the  same  form  in  our  present  national  bank- 
ing law. 

439.  First  Bank  of  the  United  States. — The  First 
Bank  of  the  United  States  was  chartered  by  Congress 
in  1791.  The  charter  was  granted  in  spite  of  strong 
opposition  on  the  part  of  those  who  inveighed  against 
the  tendency  toward  centralization  of  government,  they 
claiming  that  Congress  was  not  empowered  by  the  Con- 
stitution to  create  banks.  Alexander  Hamilton,  then 
secretary  of  the  treasury,  took  the  ground  that  this 
power  was  an  implied  one,  and  his  opinion  prevailed. 

It  was  capitalized  at  $10,000,000,  divided  into  25,000 
shares  of  $400  each.  Of  this  total  $2,000,000  was 
subscribed  by  the  government  and  paid  for  in  install- 
ments. The  remainder  was  subscribed  by  the  public, 
one-fourth  in  specie  and  the  balance  in  government  se- 
curities (bearing  interest).  The  bank  was  governed 
by  a  board  of  twenty-five  directors,  not  more  than 
three-fourths  of  whom  were  eligible  for  re-election.  No 
stockholder  was  entitled  to  more  than  thirty  votes,  no 


HISTORY  OF  BANKING  351 

matter  how  large  his  holdings,  and  foreign  stockholders 
could  not  vote  by  proxy.  The  bank  could  loan  on  real 
estate  but  could  not  hold  it  except  for  banking  purposes. 
It  could  not  trade  in  commodities,  nor  purchase  addi- 
tional government  securities.  The  same  distinction 
between  notes  and  deposits  that  appeared  in  the  Massa- 
chusetts law  was  recognized,  and  it  was  provided  that 
the  bank  could  not  become  indebted,  except  for  deposits, 
to  an  amount  greater  than  its  capital  stock.  The  char- 
ter was  to  expire  in  twenty  years. 

440.  Success  of  the  first  bank. — The  bank  enjoyed 
success  from  its  inception.  Branches  were  established 
at  New  York,  Boston,  Baltimore,  Washington,  Norfolk, 
Charleston,  Savannah,  and  New  Orleans.  The  central 
bank  with  a  capital  of  $4,700,000  was  in  Philadelphia. 
It  acquired  deposits  of  government  money,  receiving 
probably  two-thirds  of  all  money  deposited  in  banks 
by  the  Treasury.  It  paid  dividends  for  twenty  years 
at  an  average  rate  of  8  per  cent.  It  loaned  commer- 
cially, and  became  a  powerful  influence  in  establishing 
a  sound  currency. 

The  bank's  loans  to  the  government,  however,  the 
installments  on  the  original  purchase  of  stock,  and  fur- 
ther advances  to  be  paid  out  of  revenue,  were  not 
promptly  paid  and  in  1795  had  increased  to  over  $6,- 
000,000.  There  was  no  market  for  government  bonds, 
hence  it  became  necessary  for  the  government  to  sell 
its  stock,  which  it  did  in  1802.  This  sale  had  only  a 
beneficial  effect  on  the  bank,  and  it  is  hard  to  justify 
at  all  the  government's  part  ownership  of  it.  When 
the  bank  was  organized  the  government  did  not  need 
credit;  it  was  given  no  control  over  the  bank  except 
the  right  to  investigate  its  affairs,  which  it  seldom  ex- 
ercised. Hence  the  bank  was  not  made  any  more  secure 


352  MONEY  AND  BANKING 

as  a  place  of  deposit  for  government  funds;  and  it  had 
no  surplus  on  hand  to  invest.  If  the  government  be- 
came a  stockholder  for  the  sake  of  profit,  its  judgment 
was  correct  for  the  dividends  of  8  per  cent  were  paid 
annually,  and  the  stock  it  held  was  sold  at  a  considerable 
advance. 

441.  Opposition  to  recharter. — In  1809  the  stock- 
holders petitioned  Congress  for  a  renewal  of  the  charter, 
and  their  petition  was  ably  indorsed  by  a  report  from 
Secretary  of  the  Treasury  Gallatin.  He  reviewed  the 
successful  history  of  the  bank  and  recommended  that 
its  capital  be  increased  $30,000,000,  three-fifths  of  which 
it  should  be  forced  to  lend  to  the  government.  Un- 
fortunately, however,  Congress  failed  to  act  and  the 
question  was  tabled  until  the  succeeding  Congress. 
When  the  question  again  arose  in  1811  opposition  to 
the  charter  was  not  only  strong  but  organized. 

First,  those  who  believed  in  a  strict  construction  of 
the  Constitution  were  against  the  bank.  Second,  the 
Republicans,  now  in  power,  denounced  the  bank  as  an 
aristocratic  institution.  They  pointed  out  that  three- 
fifths  of  its  stock  was  in  foreign  hands.  A  majority 
of  this  was  held  in  England,  and  a  war  with  that  country 
was  imminent.  Not  pausing  to  analyze  the  regulations 
which  prevented  control  of  the  bank  by  foreign  in- 
terests, or  more  probably  forgetting  this  regulation  for 
their  own  political  purposes,  they  urged  that  in  case 
of  war  with  England  the  Bank  of  the  United  States 
would  find  itself  in  King  George's  hands.  Third,  the 
state  banks  and  the  political  enemies  of  Secretary  Gal- 
latin had  had  time  to  combine  against  the  government 
bank  and  its  champion.  The  result  was  a  vote  to  post- 
pone indefinitely  the  renewal  of  the  charter,  and  the 
dissolution  of  the  bank  followed  immediately. 


HISTORY  OF  BANKING  353 

442.  Second  Bank  of  the  United  States. — The  Sec- 
ond Bank  of  the  United  States  was  the  result  of  the 
financial  chaos  that  followed  the  dissolution  of  its  pred- 
ecessor.    The  War  of   1812   found  the   government 
funds  deposited  in  state  banks,  a  large  number  of  which 
had  sprung  up  with  the  passing  of  the  First  Bank. 
These  state  banks  were  poorly  managed,  and  in  1814 
specie  payment  was  suspended  by  all  banks  except  those 
in  New  England.     The  government  defaulted  on  the 
interest  of  the  public  debt.     Bank  notes  circulated  only 
at  a  considerable  discount,  varying  with  the  reputation 
of  the  issuing  bank.     A  government  bank  was  proposed 
in  1814  to  begin  business  under  a  suspension  of  specie 
payments,  but  it  was  not  until  1816  that  the  Second 
Bank  was  founded. 

It  was  capitalized  at  $35,000,000,  one-fifth  of  which 
was  subscribed  by  the  government.  Private  subscrip- 
tions were  payable  one-fourth  in  specie  and  the  balance 
in  government  bonds.  Thirty  per  cent  was  due  at  once 
and  the  balance  in  equal  installments  at  the  end  of  six 
and  twelve  months.  The  government's  subscription 
was  paid  in  notes,  and  it  received  $1,500,000  as  a  bonus 
for  granting  the  charter. 

The  charter  was  modeled  after  that  of  the  First 
Bank.  It  was  to  be  the  depository  of  public  funds. 
It  was  to  be  governed  by  twenty-five  directors,  five  of 
whom  were  to  be  named  by  the  President  of  the  United 
States.  Its  notes  were  made  receivable  for  all  debts 
to  the  federal  government.  Foreign  stockholders 
could  not  vote.  It  was  required  to  pay  deposits  as 
well  as  notes  in  specie,  and  a  forfeiture  of  12  per  cent 
was  provided  in  case  it  failed  to  do  so. 

443.  Redemption  of  notes  in  specie. — This  was  a 
great  step  toward  sound  banking.     Although  deposits 

VII  -S3 


354  MONEY  AND  BANKING 

had  always  been  nominally  payable  in  specie,  the  cus- 
tom had  grown  up  of  paying  them  in  the  notes  of  other 
specie  paying  banks.  If  these  banks  happened  to  be 
remote  the  notes  circulated  at  their  face  value  less  the  ex- 
pense of  redemption ;  the  result  was  a  non-uniform  cur- 
rency. While  the  new  regulation  did  not  entirely  pre- 
vent the  circulation  of  several  kinds  of  currency,  it 
helped  to  do  so,  and  was  a  recognition  of  the  status  and 
possibilities  of  the  deposit  system.  The  forfeiture  of 
12  per  cent  in  case  of  suspension  of  specie  payments 
was  intended  to  prevent  a  profit  being  made  from  sus- 
pension. Many  of  the  state  banks  had  been  able  to 
pay  dividends  when  they  could  not  redeem  either  their 
own  notes  or  deposits  except  in  the  notes  of  other  non- 
specie  payment  banks. 

444.  Mismanagement  of  the  bank. — Under  this  char- 
ter twenty-five  branches  were  established  and  the  bank 
soon  brought  about  resumption  of  specie  payment. 
This,  however,  was  the  only  benefit  it  conferred  for 
the  first  two  years  of  its  existence,  as  it  was  shamefully 
mismanaged.  Early  in  its  career  it  began  to  loan  to 
stockholders  on  stock  which  was  not  yet  fully  paid  for. 
Speculation  in  the  stock  followed,  its  price  advancing 
and  the  bank  loaning  its  par  value  freely.  The  charter 
provided  that  no  dividends  should  be  paid  on  stock 
which  was  not  fully  paid  for,  but  this  regulation  was 
violated.  The  Baltimore  branch  was  in  the  hands  of 
unscrupulous  officers  who  defrauded  it  of  large  sums. 
Hence,  up  to  1819  the  Second  Bank  of  the  United 
States  was  managed  in  such  a  way  that  the  deposit 
of  public  funds,  amounting  to  more  than  $8,000,000, 
was  greatly  endangered,  and  the  bank  itself  was  a  dis- 
grace to  the  nation. 

In  1819  Mr.  Langdon  Cheves  of  South  Carolina  was 


HISTORY  OF  BANKING  355 

elected  president  of  the  bank.  He  immediately  set 
about  correcting  the  various  abuses  that  had  sprung  up, 
reducing  loans  to  stockholders,  increasing  reserves  by 
importation  of  silver,  and  regulating  the  issue  of  notes. 
His  administration  was  so  business-like  that  the  bank 
soon  regained  popular  confidence  and  prospered  greatly 
the  ensuing  decade. 

The  constitutionality  of  the  government  bank  was 
settled  in  1819  when  the  Supreme  Court,  by  Chief 
Justice  Marshall,  handed  down  the  decision  that  the 
establishment  of  the  bank  to  assist  the  fiscal  operations 
of  the  government  was  an  implied  power  of  the  Con- 
stitution. It  was  further  decided  that  the  states  had 
no  power  to  tax  the  circulating  notes  of  the  federal 
bank  or  of  the  other  state  banks.  Both  decisions  were 
extremely  important  because  a  different  ruling  on  either 
would  have  made  impossible  not  only  the  Bank  of  the 
United  States  but  our  present  national  banking  system. 

445.  Jackson  opposed  to  the  bank. — When  Andrew 
Jackson  became  President  of  the  United  States  in  1829 
Nicholas  Biddle  was  at  the  head  of  the  bank.  The  ques- 
tion of  the  renewal  of  the  charter,  which  was  not  to  ex- 
pire until  1836,  immediately  became  prominent.  Jack- 
son was  inclined  to  object  to  the  bank  on  constitutional 
grounds,  and  his  antipathy  was  increased  by  charges 
brought  against  various  officers  of  the  bank  by  his  own 
political  associates.  His  message  to  Congress  in  1829 
plainly  showed  his  antipathy,  but  in  1831  he  spoke  in 
a  milder  tone.  He  was  still  known,  however,  as  an 
opponent  of  the  bank.  In  1831  Henry  Clay,  the  candi- 
date for  President  on  the  Whig  ticket,  came  out  em- 
phatically for  a  renewal  of  the  charter.  The  bank  was 
generally  popular  and  Clay  was  attempting  to  cap- 
italize that  popularity.  Before  the  election  a  bill  pro- 


356  MONEY  AND  BANKING 

viding  for  the  renewal  of  the  charter  was  passed  by 
Congress  and  vetoed  by  President  Jackson,  so  that  the 
question  became  the  principal  issue  of  the  ensuing  cam- 
paign. The  end  of  the  Second  Bank  of  the  United 
States  was  in  view  when  Jackson  was  elected. 

In  1833  the  government  deposits  were  withdrawn 
from  the  bank  and  cancellation  of  the  government's 
stock  was  requested.  To  pay  off  this  obligation  new 
stock  was  sold,  and  the  bank  obtained  a  charter  from 
the  State  of  Pennsylvania.  It  was  never  again  success- 
ful, however,  principally  because  its  capital  was  too 
large  for  operation  in  Philadelphia.  It  was  compelled 
to  loan  large  amounts  on  the  stocks  of  various  companies 
which  were  being  formed  in  all  parts  of  the  country. 
The  panic  of  1837  made  many  of  these  stocks  worth- 
less, and  the  bank  was  forced  to  suspend.  In  1841  it 
again  suspended,  and  went  into  liquidation.  Its  credits 
were  paid  in  full  but  the  stockholders  received  nothing. 

The  history  of  these  two  banks  is  interesting,  not  so 
much  because  of  the  various  restrictions  on  loans,  note 
issues,  etc.,  as  on  account  of  the  effect  of  their  intimate 
relation  with  and  dependence  upon  the  government. 
In  both  cases  the  banks  performed  great  service.  They 
were  both  successful  financially.  Their  failure  was  due 
to  the  fact  that  they  became  involved  in  politics,  as 
any  bank  so  chartered  must  become  in  a  country  where 
parties  and  administrations  are  constantly  changing. 
This  is  the  great  argument  against  a  federal  bank  in  the 
United  States. 

446.  State  banking. — Banking  under  charters  ob- 
tained from  the  various  states  was  of  two  kinds:  (1) 
Private  corporations  authorized  to  conduct  banks,  and 
( 2 )  banks  in  which  the  states  themselves  had  an  interest. 
The  first  class  is  of  importance  chiefly  from  a  technical 


HISTORY  OF  BANKING  357 

point  of  view,  particularly  in  regard  to  the  success  of 
the  several  plans  adopted  for  the  issue  of  notes;  the 
second,  because  of  the  fact  that  the  states  were  inti- 
mately connected  with  their  management. 

The  early  banks  of  Pennsylvania,  Massachusetts,  and 
New  York  have  already  been  mentioned;  and  reference 
has  been  made  to  other  state  banks  which  were  in  ex- 
istence during  the  life  of  the  banks  of  the  United  States. 
The  most  notable  movement  toward  sound  banking  took 
place  in  New  England,  particularly  Boston,  and  in  New 
York. 

447.  Suffolk  bank  system. — In  New  England  in  the 
early  part  of  the  century  the  same  conditions  prevailed 
in  regard  to  the  circulating  medium  that  existed  in  Phil- 
adelphia prior  to  the  establishment  of  the  Second  Bank 
of  the  United  States.  The  notes  of  country  banks  com- 
prised a  large  proportion  of  the  currency,  even  in  the 
commercial  centers.  They  circulated  at  a  discount  be- 
cause of  the  expense  of  redemption,  hence  they  quickly 
drove  the  notes  of  the  city  banks  out  of  circulation,  and  as 
they  were  not  receivable  at  par  at  the  city  banks  while 
the  notes  of  the  city  banks  were,  the  latter  naturally 
were  presented  for  payment  and  the  depreciated  notes 
continued  to  circulate. 

In  1818  the  Suffolk  Bank  was  incorporated  in  Bos- 
ton, and  it  immediately  endeavored  to  work  out  a  plan 
by  which  it  could  make  a  profit  from  the  redemption 
of  country  bank  notes.  It  offered  to  make  itself  an 
agent  of  redemption  for  the  country  banks,  agreeing 
to  accept  their  notes  at  par  provided  a  deposit  was  kept 
with  it  to  pay  it  for  the  trouble.  At  first  only  a  small 
number  of  banks  availed  themselves  of  the  privilege, 
but  the  Suffolk  Bank  retaliated  by  sending  home  for 
redemption  the  notes  of  all  banks  which  did  not  adopt 


358  MONEY  AND  BANKING 

the  plan.  The  final  result  was  that  practically  all  the 
banks  in  New  England  became  members  of  the  Suffolk 
system,  which  continued  until  the  national  banking  law 
of  1865. 

It  soon  became  a  clearing  house  for  bank  notes,  and 
just  as  the  city  clearing  houses  offset  the  credits  and 
debits  of  the  various  banks  against  each  other  in  such 
a  way  that  only  balances  are  paid  in  cash,  so  the  Suffolk 
bank  canceled  the  bank  obligations  of  all  New  Eng- 
land. In  1845  the  Massachusetts  law  was  changed  to 
provide  that  no  bank  should  pay  out  any  notes  except 
its  own,  a  provision  which  strengthened  the  Suffolk 
system  because  it  made  necessary  quick  redemption. 
All  bank  notes  issued  would  circulate  in  the  pockets  and 
tills  of  the  people  as  long  as  there  was  actual  demand 
for  them;  when  this  demand  subsided  they  would  be 
deposited  in  a  bank,  and  since  they  could  not  again  be 
paid  out  they  would  be  quickly  redeemed  at  the  Suffolk 
Bank. 

During  the  greater  part  of  the  existence  of  the  Suf- 
folk Bank  there  was  no  provision  in  Massachusetts  for 
keeping  a  specified  reserve.  The  system  worked  so 
well,  in  fact,  that  specie  was  seldom  demanded.  In 
1858  the  legislature  passed  a  law  providing  for  a  reserve 
of  15  per  cent  against  both  notes  and  deposits.  They 
were  thus  recognized  as  liabilities  of  the  bank,  equal  in 
every  respect;  nor  was  there  any  reason  for  giving  the 
notes  a  preference  or  maintaining  a  special  reserve  for 
them  under  the  system  of  quick  redemption  which  ex- 
isted. The  notes  were  not  intended  for  general  circu- 
lation but  for  redemption  when  the  need  for  them 
disappeared,  in  the  same  manner  that  our  checks  and 
drafts  are  redeemed  to-day.  Under  this  system  the 


HISTORY  OF  BANKING  359 

average  life  of  the  bank  note  was  found  to  be  about 
five  weeks. 

448.  New  York  systems. — The  banks  of  New  York 
were  operated  along  different  lines.     There  were  two 
plans  of  note  issue:     (1)   The  safety  fund  system  and 
(2)  the  bond  deposit  or  free  banking  system.     The  first 

is  especially  worthy  of  note  because  of  the  recent  pro- 
posal of  the  Democratic  Party  that  bank  deposits  be 
guaranteed  by  the  government,  a  proposal  which  rests 
on  the  same  basis.  The  second  plan  is  interesting  be- 
cause it  was  adopted  by  the  federal  government  in  1865 
to  secure  the  note  issues  of  the  national  banks. 

449.  Safety  fund  system. — The  safety  fund  system 
was  established  in  1829.     Each  bank  was  required  to 
contribute  annually  one-half  of  1  per  cent  of  its  capital 
to  a  special  fund  in  the  hands  of  the  states  until  its 
contributions  should  amount  to  3  per  cent  of  its  capital. 
Out  of  this  fund  all  the  debts  of  failed  banks  (except 
those  to  stockholders  on  their  stock)   were  to  be  paid 
after  the  assets  of  the  bank  had  been  exhausted.     In 
1837  the  law  was  amended  so  that  the  notes  of  failed 
banks  could  be  paid  immediately,  provided  they  did  not 
amount  to  more  than  two-thirds  of  the  money  in  the 
fund.     In  that  year  several  banks  failed  and  their  notes 
suffered  no  depreciation.     After  1840,  however,  the 
number  of  banks  which  failed  was  so  large  that  the 
safety  fund  was  too  small  to  meet  all  their  obligations, 
both  notes  and  deposits.     Accordingly  in  1843  the  law 
was  again  amended  so  that  the  fund  was  made  applica- 
ble only  to  the  payment  of  the  notes  of  the  insolvent 
banks. 

450.  Bond  deposit  system. — In  1838,  however,  the 
bond  deposit  system  was  established  and  all  banks  incor- 


360  MONEY  AND  BANKING 

porated  after  that  date  did  so  under  that  plan.  This 
weakened  the  safety  fund  because  there  were  no  new 
contributions  to  it  and  the  burden  fell  upon  a  constantly 
decreasing  number  of  banks.  In  1846  the  new  consti- 
tution of  New  York  provided  that  note  holders  were 
to  have  a  first  lien  on  all  the  assets  of  a  bank  and  that 
in  case  of  failure  stockholders  were  to  be  liable  for  an 
amount  equal  to  their  holdings  of  stock.  It  further 
provided  that  no  special  charters,  such  as  those  under 
which  the  safety  fund  banks  operated,  were  to  be 
granted  or  renewed.  Thus  the  safety  fund  system 
gradually  died  out  with  the  expiration  of  the  charters, 
the  last  of  which  expired  in  1866.  All  claims  against 
it  were  paid  in  full. 

451.  Mistakes  of  the  system. — The  safety  fund  sys- 
tem failed  because  of  mistakes  in  detail  rather  than 
through  fundamental  defects.  The  fund  at  the  start 
should  have  been  made  applicable  only  to  the  payment 
of  notes.  Its  real  function  was  to  provide  a  uniform 
currency  which  anyone  might  accept  without  question. 
While  deposits  are  equal  liabilities  of  a  bank,  no  one 
is  ever  forced  to  accept  a  deposit  in  a  particular  bank, 
whereas  he  may  be  often  compelled  to  accept  its  notes 
without  any  knowledge  of  the  stability  of  the  bank. 
It  was  this  general  acceptance  which  the  safety  fund 
aimed  to  accomplish,  and  it  is  obvious  that  the  guarantee 
of  notes  would  have  been  sufficient.  By  1846  this  and 
other  defects  had  been  corrected  but  the  system  had 
already  received  its  death  blow.  Had  the  defects  been 
corrected  earlier  it  is  probable  that  the  bond  deposit 
plan  would  never  have  been  adopted. 

The  chief  influences  which  led  to  the  bond  deposit 
law  of  1838  were  political.  Charters  under  the  safety 
fund  plan  had  been  granted  only  by  special  act  of  the 


HISTORY  OF  BANKING  361 

legislature,  and  there  was  a  pronounced  sentiment  for 
free  banking.  The  new  system,  however,  might  have 
been  established  under  the  safety  fund  plan  had  that 
been  working  smoothly. 

452.  Free  banking  system. — The  Free  Banking  Law 
authorized  any  person  or  association  of  persons  to 
receive  circulating  notes  to  be  signed  and  issued  as 
money  who  would  deposit  with  the  comptroller  the 
stocks  of  the  United  States,  of  the  State  of  New  York 
or  other  approved  states,  or  mortgages  secured  by  real 
estate  worth  twice  the  amount  of  the  mortgage.  This 
deposit  of  collateral  was  intended  to  insure  the  note 
holder  against  loss.  No  provision  for  actual  redemp- 
tion in  specie  was  required.  Anyone  who  possessed 
the  necessary  securities  might  enter  the  banking  busi- 
ness, and  it  is  evident  that  many  of  them  did.  Over  130 
new  banks  were  organized  before  1840.  Failures 
quickly  resulted,  and  it  was  found  that  in  many  cases 
the  securities  deposited  were  not  sufficient  to  meet  the 
notes.  Real  estate  mortgages,  however  valuable,  were 
not  quick  assets,  hence  the  law  was  finally  changed  so 
that  only  the  stocks  of  the  United  States  and  of  New 
York  were  available  for  deposit. 

The  notes  circulated  at  first  at  considerable  discount 
but  this  was  overcome  to  a  certain  extent  in  1840  by 
an  amendment  to  the  law  which  necessitated  redemp- 
tion of  the  notes  of  interior  banks  in  New  York  and 
Albany  at  a  discount  not  greater  than  one-half  of  1  per 
cent.  This,  however,  gave  an  advantage  to  the  coun- 
try banker  because  of  the  profit  he  could  make  by  loan- 
ing his  notes  at  par  and  redeeming  them  at  a  discount. 
Hence  many  persons  in  the  cities  issued  their  notes  in 
the  country  towns.  The  business  of  these  banks  was 
solely  to  issue  notes.  They  had  no  permanent  banking 


362  MONEY  AND  BANKING 

\ 

houses,  and  received  no  deposits.  In  1848  this  condi- 
tion was  somewhat  bettered  by  a  law  requiring  banks 
of  issue  to  become  banks  of  deposit  as  well,  but  it  was 
never  carefully  enforced.  The  effect  of  these  various 
amendments,  however,  and  of  the  constitution  of  1836 
was  to  improve  greatly  the  condition  of  the  issuing 
banks,  so  that  failures  after  1850  were  infrequent  and 
in  almost  all  cases  the  notes  were  redeemed  at  par. 
After  1860  there  were  no  failures  which  resulted  in 
loss  to  note  holders. 

This  system  was  copied  by  Illinois,  Indiana,  and  Wis- 
consin but  with  disastrous  results.  In  none  of  these 
states  did  the  system  survive  long  enough  to  become 
perfected.  In  Illinois  particularly  a  large  amount  of 
the  securities  deposited  were  those  of  the  Southern 
States,  which  became  valueless  at  the  outbreak  of  the 
war.  The  bank  currency  circulated  at  great  discounts, 
varying  with  the  reputation  of  the  issuing  bank.  In 
1857  there  were  112  banks  in  Illinois;  in  1861  only  7, 
and  the  note  holders  had  realized  less  than  40  cents  on 
the  dollar. 

The  only  advantage  of  this  system  over  that  of  the 
safety  fund  is  security,  which  was  proved  by  the  ex- 
perience of  New  York  after  the  list  of  acceptable  stocks 
had  been  restricted  to  those  of  the  United  States  and  of 
New  York.  No  currency  could  be  more  secure,  that 
is,  more  certain  of  ultimate  redemption.  This,  how- 
ever, is  not  the  only  desideratum  of  a  credit  currency. 
Current  redemption  is  as  important  as  ultimate  redemp- 
tion, and  in  this  the  system  is  defective.  Moreover,  the 
system  was  rigid — when  the  banks  deposited  securities 
they  were  given  the  right  to  issue  so  many  notes,  and 
they  could  not  issue  additional  amounts  no  matter  what 
the  needs  of  business  might  be.  In  other  words,  the 


HISTORY  OF  BANKING  363 

system  was  inelastic,  an  attribute  which  along  with  that 
of  security  it  handed  down  to  our  present  currency 
system  and  against  which  most  of  the  attacks  of  to-day 
are  directed. 

453.  Experience  in  other  states. — The  history   of! 
banks  in  which  the  various  states  were  part  owners  was, 
in  the  main,  disastrous.     Kentucky  tried  the  experiment 
in  1806  and  again  in  1820.     Alabama  in  1820  sub- 
scribed   two-fifths    of  the    capital    of    the    Bank    ofl 
Alabama,   issuing   bonds   in   payment.     The   original 
restrictions  on  loans  were  ample  but  they  were  con- 
stantly violated.     Loans  were  freely  made  to  members 
of  the  legislature  and  their  friends,  and  in  ten  years 
the  discounts  increased  from  $500,000  to  $20,000,000. 
The  panic  of  1837  found  a  large  amount  of  these  loans 
worthless,  and  confidence  in  the  notes  disappeared,  to 
be  followed  by  a  period  of  business  stagnation.     In 
1845  the  charter  expired  and  was  not  renewed.     Mis- 
sissippi, Arkansas,  Florida,  and  Louisiana  had  similar 
experiences.     The  Union  Bank  of  Louisiana  was  estab- 
lished in  1832  with  a  capital  of  $7,000,000  raised  by  a 
sale  of  state  bonds.     It  failed  ten  years  later,  and  was 
followed  by  the  establishment  of  private  banks  under 
sound  laws.     Missouri's  experience  was  not  so  calam- 
itous, although  the  Bank  of  Missouri  was  never  a  great 
success,  and  the  state's  connection  with  it  was  severed 
in  1866. 

454.  Indiana  and  Ohio. — The  Bank  of  Indiana  was 
the  most  successful.     It  was  incorporated  in  1834  with  a 
capital  of  $1,600,000,  one-half  of  which  was  subscribed 
by  the  state.    It  was  given  a  monopoly  of  banking  in  the 
state  and  the  right  to  establish  branches.     Each  branch 
was  allotted  a  certain  capital  and  the  issue  of  notes  was 
restricted  to  an  amount  twice  as  great  as  the  capital. 


364  MONEY  AND  BANKING 

Each  branch  bank  was  required  to  accept  the  notes  of 
other  branches  at  par  and  to  redeem  its  own  notes  in 
specie.  During  the  first  years  of  its  existence  it  at- 
tempted to  loan  on  real  estate  security,  but  the  danger  of 
this  custom  was  soon  realized  and  it  was  discontinued. 
Subsequently  it  loaned  to  farmers  on  their  personal  notes 
and  on  their  crops,  but  the  loans  were  always  for  short 
periods.  In  this  way  it  transacted  business  on  sound 
banking  principles  and  continued  to  thrive  until  1865, 
when  the  federal  tax  on  state  bank  note  issues  forced 
it  out  of  existence. 

The  State  Bank  of  Ohio  was  likewise  well  managed 
and  highly  successful.  It  had  a  capital  of  $3,300,000 
and  thirty-six  branches.  Note  issue  was  restricted  to 
an  amount  not  greater  than  twice  the  capital,  and  was 
further  safeguarded  by  a  safety  fund  of  10  per  cent 
deposited  with  a  board  of  control.  It  passed  out  of 
existence  with  the  expiration  of  its  charter  in  1866. 

The  state  banks,  as  a  rule,  did  not  fail  for  the  same 
reason  that  caused  the  downfall  of  the  two  United 
States  banks.  While  in  some  instances,  notably  in 
Kentucky  and  Alabama,  the  banks  became  involved  in 
politics,  their  failure  was  generally  due  to  defects  of 
organization  and  management. 


CHAPTER  XXV 

NATIONAL  BANKING  SYSTEM 

455.  The  National  Bank  Act. — The  establishment  of 
the  national  banking  system  was  the  result  of  the  un- 
satisfactory financial  conditions  which  obtained  during 
the  Civil  War.  The  currency  of  the  country  was  com- 
posed largely  of  the  notes  of  over  1,500  state  banks, 
a  large  amount  of  which  was  worthless  and  almost  all 
of  which  circulated  only  at  a  discount  when  it  was  at  a 
distance  from  its  place  of  redemption.  In  addition  to 
this  currency  trouble  the  fiscal  situation  of  the  govern- 
ment was  unsatisfactory.  It  had  been  forced  because 
of  the  absence  of  market  for  its  bonds  to  raise  money 
by  the  issue  of  legal  tender  notes.  These  notes  im- 
paired its  credit  and  themselves  had  to  be  redeemed. 
Consequently  it  was  anxious  if  possible  to  strengthen 
the  market  for  bonds.  Secretary  Chase's  plan  for  the 
establishment  of  the  national  banking  system  com- 
mended itself  because  it  would  correct  in  a  measure  both 
of  these  ills.  In  Secretary  Chase's  words  the  principal 
features  of  the  plan  were: 

First,  a  circulation  of  notes  bearing  a  common  impression,  and 
authenticated  by  a  common  authority ;  second,  the  redemption  of 
these  notes  by  the  associations  and  institutions  to  which  they  may 
be  delivered  for  issue,  and,  third,  the  security  of  that  redemption 
by  the  pledge  of  United  States  stocks,  and  an  adequate  pro- 
vision of  specie. 

In  this  plan  the  people  in  their  ordinary  business  would  find 
the  advantages  of  uniformity  in  currency;  of  uniformity  in  se- 
curity ;  of  effectual  safeguard,  if  effectual  safeguard  is  possible, 


366  MONEY  AND  BANKING 

against  depreciation,  and  of  protection  from  losses  in  discounts 
and  exchanges;  while  in  the  operations  of  the  Government,  the 
people  would  find  the  further  advantages  of  a  large  demand  for 
government  securities,  and  of  increased  facilities  for  obtaining 
the  loans  required  by  the  war. 

456.  Market  for  United  States  bonds. — The  chief 
feature  of  the  plan  was  the  requirement  that  all  banks 
which  desired  to  incorporate  under  the  national  name 
should  buy  government  bonds,  deposit  them  with  the 
Treasury  and  receive  circulating  notes  to  the  amount  of 
90  per  cent  of  their  bond  deposit.     Thus  these  notes 
would  be  uniform  because  they  were  all  to  be  printed 
by  the  government;  and  they  would  always  be  secure 
because  the  deposited  bonds  were  pledged  to  their  re- 
demption.    Furthermore,  a  new  demand  for  govern- 
ment bonds  would  result  which  would  greatly  facilitate 
the  nation's  borrowing  power. 

457.  Early  history  of  the  act. — This  plan  was  recom- 
mended by  Secretary  Chase  as  early  as  1861  but  it  was 
not  until  1863  that  it  became  a  law.     It  did  not,  how- 
ever, result  in  as  great  a  benefit  to  the  national  finances 
as  had  been  expected.     There  was  a  decided  prejudice 
against  the  issue  of  notes  secured  by  the  deposit  of 
bonds,  the  result  of  the  failure  of  the  several  state  sys- 
tems which  operated  on  that  plan.     Furthermore,  the 
original  act  was  defective  in  many  respects.     The  state 
banks,  a  majority  of  which  had  been  expected  to  incor- 
porate under  the  new  law,  did  not  do  so  in  any  large 
numbers ;  therefore  there  was  no  great  demand  for  gov- 
ernment bonds. 

In  1864  the  law  was  amended  making  the  conditions 
of  incorporation  somewhat  more  attractive,  but  it  was 
not  until  1865,  when  a  law  was  passed  providing  for  a 
tax  of  10  per  cent  on  all  notes  issued  by  state  banks, 


NATIONAL  BANKING  SYSTEM  367 

that  conversion  of  state  into  national  banks  became 
general.  By  this  provision  all  state  banks  which  wished 
to  use  notes  were  forced  into  the  new  system.  Thus  the 
demand  for  bonds  did  not  come  until  the  war  was  over 
and  the  necessity  of  their  immediate  sale  had  disap- 
peared. 

This  national  bank  law,  its  operations  perfected  by 
various  amendments  in  1874,  1875,  and  1882,  is  to-day 
the  backbone  of  our  banking  system.  Its  provisions, 
therefore,  as  they  exist  to-day  are  worthy  of  careful 
attention. 

458.  Comptroller  of  the  currency. — Control  of  the 
national   banking   system   is   vested   in   a   bureau   of 
the  United  States  Treasury  under  the  direction  of  the 
comptroller  of  the  currency.     It  is  the  function  of  this 
department  to  supervise  the  issue  and  redemption  of 
notes,  the  granting  of  charters,  etc.,  and  to  enforce  all 
the  various  provisions  of  the  law.     To  accomplish  this 
end,  examiners  are  appointed  by  the  comptroller,  whose 
duty  it  is  to  examine  from  time  to  time  the  affairs  of 
each  bank  in  the  system.     These  examinations  are  made 
at  any  time  the  comptroller  selects,  and  without  previous 
notice  to  the  bank.     The  examiner  has  access  to  all  the 
books  and  accounts  of  the  bank,  and  is  required  to  make 
a  thorough  investigation  of  all  the  loans  outstanding. 
This  examination  is  repeated  in  detail  to  the  comptroller 
who  calls  the  bank  to  account  for  any  illegal  practices 
or  situations  which  may  exist.     Once  a  year  the  comp- 
troller makes  a  report  to  Congress  showing  the  condition 
of  the  banks  in  detail.     In  case  of  the  failure  of  a  bank 
the  comptroller  appoints  a  receiver. 

459.  Summary  of  National  Bank  Act. — Charters  are 
granted  for  periods  not  longer  than  twenty  years.     Ap- 
plication must  be  made  by  not  fewer  than  five  persons, 


368  MONEY  AND  BANKING 

with  whose  good  character  the  comptroller  must  be  sat- 
isfied. Fifty  per  cent  of  the  capital  must  be  paid  in 
before  the  bank  can  open,  and  the  remainder  within  six 
months.  The  minimum  capital  for  cities  of  3000  pop- 
ulation or  less  is  $25,000;  for  cities  between  3000  and 
6000,  $50,000;  for  those  between  6000  and  50,000, 
$100,000;  and  for  those  greater  than  50,000,  $200,000. 

Each  bank  must  have  a  board  of  directors  of  not  less 
than  five  members,  each  of  whom  must  own  ten  shares 
of  stock.  The  stockholders  are  individually  liable  for 
all  obligations  of  the  bank  up  to  an  amount  equal  to 
their  holdings  of  stock.  In  case  of  failure  they  are 
often  assessed  to  pay  depositors. 

The  technical  powers  of  national  banks  have  already 
been  considered.  Briefly  they  are:  (1)  To  receive 
deposits,  (2)  issue  notes,  (3)  loan  credit  on  personal 
security,  and  (4)  discount  notes  and  other  evidences  of 
debt.  A  bank  may  own  only  such  real  estate  as  is 
necessary  for  conducting  its  business  and  as  comes  into 
its  possession  in  settlement  of  previously  contracted 
debts.  In  the  latter  case  it  must  be  sold  within  five 
years.  It  cannot  loan  more  than  one-tenth  of  its  cap- 
ital and  surplus  to  one  individual  or  corporation. 

Before  a  national  bank  can  open  it  must  deposit  with 
the  United  States  Treasury  a  certain  amount  of  govern- 
ment bonds.  This  amount  varies  with  the  capitalization 
of  the  bank.  For  banks  with  a  capital  of  $150,000  or 
less,  the  requirement  is  one-fourth  of  its  capital;  for 
those  over  $150,000  it  is  one-third.  This  amount  must 
be  deposited  regardless  of  whether  or  not  it  expects  to 
issue  notes.  It  is  entitled,  however,  if  it  so  desires,  to 
receive  from  the  comptroller  circulating  notes  equal  in 
amount  to  the  par  value  of  the  deposited  bonds.  These 
notes  are  "receivable  at  par  in  all  parts  of  the  United 


NATIONAL  BANKING  SYSTEM  369 

States  in  payment  of  all  taxes  and  excises,  and  all  other 
dues  to  the  United  States  except  duties  on  imports; 
and  also  for  all  salaries  and  other  debts  and  demands 
owing  by  the  United  States  to  individuals,  corporations 
and  associations  within  the  United  States  except  inter- 
est on  the  public  debt."  They  are  also  legal  tender  in 
payment  of  any  debts  to  national  banks. 

460.  Circulating  notes. — The  notes  must  be  redeemed 
on  demand  in  lawful  money  at  the  counter  of  the  issuing 
bank;  and  to  further  facilitate  redemption  each  bank 
is  required  to  deposit  with  the  Treasury  an  amount  equal 
to  5  per  cent  of  its  outstanding  circulation.  When 
notes  are  presented  to  the  government  they  are  redeemed 
out  of  this  fund ;  circulation  may  be  retired  by  redeem- 
ing the  notes  over  the  bank's  counter  and  sending  them 
to  Washington  for  cancellation,  or  by  depositing  money 
to  an  equal  amount  in  the  Treasury.  The  deposited 
bonds  are  then  redeemed.  The  law  restricts  redemp- 
tion, however,  by  providing  that  not  more  than  $3,000,- 
000  of  national  bank  notes  may  be  retired  in  any  one 
month.  The  notes  are  subject  to  taxation  by  the  gov- 
ernment. When  they  are  secured  by  the  2  per  cent 
bonds,  the  banks  must  pay  one-half  of  1  per  cent  annu- 
ally on  the  average  circulation;  when  secured  by  higher 
rate  bonds  the  tax  is  1  per  cent  annually.  The  expense 
of  redemption  is  also  borne  by  the  banks.  It  is  esti- 
mated that  it  amounts  to  about  $63  for  each  $100,000  of 
circulation. 

All  banks  are  required  to  keep  a  certain  amount  of 
lawful  money  on  hand  as  reserve.  In  New  York,  Chi- 
cago, and  St.  Louis — designated  central  reserve  cities — 
this  amount  is  25  per  cent  of  the  deposits.  In  certain 
other  cities,  called  reserve  cities,  the  amount  is  25  per 
cent,  but  one-half  of  this  may  consist  of  demand  de- 

VII— 24 


570  MONEY  AND  BANKING 

posits  in  New  York,  Chicago,  or  St.  Louis.  All  other 
banks  must  keep  a  reserve  of  15  per  cent,  three-fifths 
of  which  may  be  deposited  in  the  reserve  cities.  The  5 
per  cent  redemption  fund  may  be  counted  as  a  part  of 
the  reserve.  The  enforcement  of  this  reserve  provision 
is  one  of  the  chief  duties  of  the  bank  examiner  and 
the  comptroller. 

There  were  in  1909,  6893  national  banks,  with  a  total 
note  circulation  of  $648,696,210.  To  secure  this  circu- 
lation the  Banks  had  purchased  and  deposited  with  the 
Treasury  $649,389,510  of  government  bonds.  A  ma- 
jority of  these  bonds  bear  only  2  per  cent  interest,  the 
lowest  rate  paid  by  any  nation  in  the  world.  Thus  the 
prediction  that  the  law  would  create  a  market  for  gov- 
ernment bonds  has  been  fulfilled.  The  second  reason 
for  its  adoption — that  it  would  provide  a  uniform  cur- 
rency— has  likewise  been  accomplished,  for  national 
bank  notes  have  always  circulated  freely  and  without 
discount.  The  note  of  the  Maine  bank  is  equally 
acceptable  in  California  as  that  of  the  San  Francisco 
bank. 

461.  Evils  of  the  national  banking  system. — The 
danger  of  the  system,  however,  is  in  the  price  that  is 
paid  for  these  benefits.  In  making  the  currency  stable 
and  uniform  it  has  been  made  inflexible;  and  in  requir- 
ing a  deposit  of  government  bonds  a  system  has  been 
founded  which  necessitates  a  continuance  of  the  na- 
tional debt.  The  desirability  of  paying  the  national 
debt  when  the  financial  condition  of  the  government 
permits  has  already  been  pointed  out.  The  first  men- 
tioned and  greatest  danger — the  inflexibility  of  the 
currency; — will  be  considered  in  the  following  chapter. 


CHAPTER  XXVI 

PRESENT  CONDITIONS  OF  BANKING  IN  THE  UNITED 

STATES 

462.  The  development  of  bank  deposit  currency. — 
The  history  of  banking  in  the  United  States  since 
the  establishment  of  the  national  banking  system  and 
the  attendant  restrictions  upon  note  issue  by  the  state 
banks,  deals  chiefly  with  the  development  of  the  deposit 
function.  The  following  table  shows  the  increase  of 
deposits  relative  to  capital  and  note  issues  in  1909  com- 
pared with  1865: 

1865.  1909. 

Dollars.  Dollars. 

National  banks  $1,513,000,000  $6,893,000,000 

Capital  and  surplus 431,900,000  1,521,000,000 

Deposits    549,100,000  4,826,000,000 

Notes    171,000,000  648,000,000 

While  national  banks  have  increased  four  and  one-half 
times  in  number,  the  capital  and  surplus  three  and  one- 
half  times,  and  the  notes  four  times,  the  deposits  have 
increased  eight  and  one-half  times.  In  addition  to  this, 
moreover,  must  be  counted  the  $8,000,000,000  of  deposits 
in  state  banks  which  issue  no  notes  whatever. 

We  have  seen  that  this  deposit  system  gives  rise  to  the 
most  perfect  currency  known,  a  currency  which  per- 
forms a  vast  amount  of  money  work  at  a  minimum  cost 
and  which  expands  and  contracts  during  ordinary  times 
with  the  varying  needs  of  business.  To  this  function 
the  national  banking  law  has  completely  subordinated 
the  issue  of  notes. 

It  may  be  well  to  reiterate  the  points  of  similarity 

371 


372  MONEY  AND  BANKING 

and  difference  between  notes  and  deposits.  Both  are 
demand  obligations  of  the  bank.  The  difference  is 
chiefly  one  of  form  which  gives  to  the  note  greater 
acceptability  because  of  its  uniformity.  The  person 
who  accepts  the  bank  note  relies  entirely  upon  the  sta- 
bility of  the  bank,  whereas  one  who  accepts  a  check 
relies  upon  the  personal  credit  of  the  maker.  '  The 
courts  have  held  that  the  tender  of  a  check  does  not 
constitute  payment  until  the  check  itself  is  redeemed  at 
the  bank,  provided  redemption  is  requested  within  a 
reasonable  time.  It  is  obvious,  therefore,  that  the  note 
performs  a  function  which  the  deposit  cannot  perform, 
namely,  circulation  beyond  the  reputation  of  the  original 
holder  of  the  bank  credit. 

463.  Limitation  of  deposit  currency. — There  are 
parts  of  the  country,  particularly  the  rural  districts  of 
the  South  and  West,  where  banking  facilities  are  poor 
and  where  they  must  use  either  notes  or  actual  money. 
Furthermore,  at  certain  times  of  the  year  their  demand 
for  currency  of  one  form  or  another  increases.  It  is 
obviously  poor  economy  to  force  these  districts  to  use 
gold  in  their  hand  to  hand  transactions  when  that  gold 
can  perform  three  times  the  money  work  if  held  in  bank 
reserves  as  a  basis  for  the  deposit  currency.  Whereas 
the  deposit  currency  will  expand  to  meet  the  seasonal 
increases  of  business  in  the  financial  centers,  it  does  not 
aid  in  any  way  the  rural  community  which  needs  more 
actual  money.  For  this,  if  for  no  other  reason,  the 
subordination  of  the  note  issue  function  has  prevented 
the  greatest  economy  in  banking. 

The  great  danger  of  our  present  system,  however, 
lies  in  the  reserve  requirements  and  customs.  All  banks 
are  permitted  to  keep  a  portion  of  their  reserve  on 
deposit  in  reserve  city  banks.  This  permission  was 


PRESENT  CONDITIONS  OF  BANKING         378 

incorporated  into  the  law  with  the  idea  of  enabling  the 
country  banker  to  keep  without  expense  a  city  account 
as  a  basis  for  exchange.  A  further  reason  was  to  in- 
crease the  mobility  of  loanable  funds  by  enabling  the 
city  banker  to  loan  in  the  large  centers  the  deposits  of 
the  country  bank.  These  needs  exist  to-day  as  they  did 
then,  but  the  loaning  by  the  city  banker  of  the  country 
banker's  deposits  has  been  so  greatly  abused  that  its 
dangers  have  become  as  great  as  its  benefits. 

464.  Seasonal  demands. — This  abuse  has  grown  out 
of  the  custom  of  the  country  banks  of  depositing  in 
financial  centers  not  only  a  portion  of  their  reserve  dur- 
ing certain  seasons  of  the  year  but  of  a  large  amount 
of  additional  cash.  Since  competition  between  the  city 
banks  has  resulted  in  the  payment  of  interest  on  country 
balances,  these  deposits  must  be  loaned.  And  since 
they  are  demand  deposits  they  must  be  loaned  on  de- 
mand or  call.  As  the  only  field  for  this  sort  of  loan  is 
in  the  stock  market,  the  promotion  of  speculation  is  the 
chief  function  of  these  country  balances. 

When  the  demand  for  loans  as  for  actual  money 
increases  in  the  country,  as  it  invariably  does  in  the  late 
summer,  these  deposits  are  withdrawn  and  shipments  of 
currency  requested.  Loans  must  be  sharply  contracted 
in  the  financial  centers.  The  deposit  currency  will  not 
meet  the  need  because  the  demand  is  for  circulating 
medium  of  general  acceptability.  Here  is  a  demand, 
therefore,  that  under  a  system  of  elastic  note  issue  could 
be  financed  without  shipment  of  gold,  a  consequent  de- 
pletion of  reserves  and  calling  of  loans. 

Perhaps  it  is  well  that  under  our  system  of  reserve 
deposits  we  have  this  check  upon  speculation  but  the 
desideratum  is  a  system  which,  by  enabling  the  country 
banker  to  increase  his  own  currency  supply,  will  lessen 


374.  MONEY  AND  BANKING 

the  necessity  of  keeping  cash  balances  in  the  cities. 
This  would  increase  his  purchases  of  commercial  paper 
with  funds  diverted  from  the  stock  market. 

465.  Depletion  of  reserves. — This  danger  of  deple- 
tion of  reserves  is  most  acute  in  times  of  panic.     There 
is  then  a  general  demand  for  liquidation  of  all  credits, 
including  these  deposit  credits.     Bank  "runs"  are  de- 
plored by  all  bankers,  yet  it  is  the  country  banks  them- 
selves which  are  the  first  to  withdraw  deposits.     Each 
bank  is  anxious  to  increase  the  cash  reserve  in  its  own 
vaults,  and  this  can  be  done  only  at  the  expense  of  some 
other  bank.     As  reserves  are  depleted  loans  must  be 
called,  and  the  loaning  power  of  the  banks  is  sadly  crip- 
pled at  a  time  when  it  is  greatly  needed.     With  the 
calling  of  loans  come  falling  prices,  and  if  borrowers 
cannot  borrow  they  must  sell  their  property  at  great 
sacrifice.     It  would  not  be  the  function  of  bank  notes 
to  prevent  failures  of  concerns  which  were  over-ex- 
tended and  unhealthy  but  the  issue  of  true  bank  notes 
at  such  times  would  save  many  solvent  firms  temporarily 
in  need  of  funds. 

This  withdrawal  of  deposits  becomes  so  general  both 
on  the  part  of  the  individual  and  the  country  bank  that 
during  the  recent  panic  the  city  banks  were  forced  to 
refuse  the  payment  of  deposits  in  currency.  This  has 
been  done  illegally,  of  course,  but  at  such  times  expedi- 
ency rather  than  legality  is  the  paramount  issue.  In 
this  way  only  have  bank  reserves  been  maintained. 

466.  Government   deposits. — The    Aldrich-Vreeland 
Law,  enacted  by  Congress  after  the  panic  of  1907,  at- 
tempted the  alleviation  of  this  condition.     Under  the 
system  prior  to  1907  the  government  could  deposit  sur- 
plus funds  in  national  banks  only  when  the  deposit  was 
secured  by  the  hypothecation  of  government  bonds. 


PRESENT  CONDITIONS  OF  BANKING         375 

During  the  recent  panic  the  secretary  of  the  treasury 
not  only  issued  government  bonds  to  be  used  as  a  basis 
for  government  deposits  but  also  accepted  other  stand- 
ard bonds  in  their  stead.  This  was  found  to  be  eif ective 
as  well  as  safe,  and  was  legalized  by  the  Aldrich-Vree- 
land  Law  which  authorizes  the  acceptance  by  the  gov- 
ernment of  certain  classes  of  municipal  bonds.  This 
should  always  have  a  beneficial  effect  in  times  of  panic, 
provided  the  government  has  a  money  surplus. 

A  more  certain  method  of  obtaining  money  to  increase 
reserves  is  the  purchase  of  gold  abroad.  Gold  may 
always  be  obtained  provided  a  sufficiently  high  price  is 
bid  for  it.  The  large  banks,  particularly  those  in  New 
York,  can  exchange  their  interest-earning  resources,  a 
large  amount  of  which  are  well  secured  stocks  and  bonds, 
for  gold  in  the  markets  of  the  world.  Obviously,  how- 
ever, this  method  is  extremely  slow  and  very  likely  to 
be  expensive,  as  it  involves  the  sale  of  good  collateral 
at  sacrifice  prices. 

467.  Inelasticity. — Although  the  aggregate  amount 
of  notes  outstanding  has  increased  four  times  in  amount 
since  1865,  the  increase  has  had  nothing  to  do  with  the 
expansion  and  contraction  of  business.  A  perfect  cur- 
rency must  have  the  attribute  of  elasticity,  that  is,  not 
only  the  ability  to  expand  when  necessary  but  the  power 
to  contract  automatically  when  the  necessity  for  expan- 
sion is  removed.  In  neither  respect  do  our  own  national 
bank  notes  meet  this  need.  The  requirement  that  bonds 
must  be  purchased  and  deposited  in  advance,  makes  the 
procedure  so  slow  that  oftentimes  the  notes  cannot  be 
issued  until  the  demand  for  them  has  disappeared. 
Contraction  is  even  slower  because  of  the  restriction  that 
only  $3,000,000  in  the  aggregate  may  be  retired  in  any; 
one  month. 


376  MONEY  AND  BANKING 

468.  Expansion  of  bank  circulation. — As  a  matter  of 
fact  the  amount  of  notes  outstanding  varies  not  at  all 
with  the  business  needs  of  the  country  but  entirely  with 
the  price  of  government  bonds.  Upon  this  latter  and 
the  current  commercial  rate  of  interest  depend  the  profit 
to  be  made  out  of  circulation.  When  bonds  are  low 
there  is  a  tendency  toward  purchasing  them  and  increas- 
ing circulation;  when  they  are  high  the  tendency  is  in 
the  opposite  direction.  The  National  City  Bank  of 
New  Yorkj  in  a  recent  circular,  states : 

Owing  to  the  fact  that  the  bank  must  part  with  more  money 
to  buy  the  bonds  which  it  will  require  as  a  basis  for  circulation 
than  it  will  receive  back  in  circulating  notes  (because  of  the  pre- 
mium on  government  bonds)  its  profits  in  circulation  increase  as 
the  average  rate  of  interest  in  the  money  market  declines;  and 
as  average  money  market  rates  advance,  the  profits  on  circula- 
tion decline.  This  is  caused  from  the  fact  that  it  could  loan 
the  entire  sum  which  it  invests  in  bonds  at  the  average  money 
market  rate,  but  if  it  takes  out  circulation  it  can  only  loan  an 
amount  equal  to  the  par  value  of  the  bonds  and  loses  the  interest 
on  the  premium. 

The  higher  the  market  rate  of  interest  the  greater 
will  be  the  loss  on  this  premium,  hence  a  smaller  profit 
on  circulation.  Inasmuch  as  the  rate  of  interest  in- 
creases with  increased  demand  for  money,  the  profit  on 
circulation  declines  where  an  increase  of  notes  is  most 
needed.  The  dependence  of  the  aggregate  amount  of 
circulation  upon  these  two  influences  was  never  more 
completely  proved  than  during  1908.  Both  the  price  of 
government  bonds  and  the  rate  of  interest  were  very 
low;  and  in  response  thereto  circulation  increased  many 
million  dollars. 

It  is  obvious  that  comprehensive  reform  is  necessary 


PRESENT  CONDITIONS  OF  BANKING          377 

if  the  nation  is  to  have  a  currency  which  will  finance 
economically  its  business  needs  and  enable  it  to  pass 
from  periods  of  great  activity  to  quietude  without  com- 
plete paralysis  of  its  economic  machinery.  The  chief 
defects  of  the  present  system  are  decentralization  and 
inelasticity. 

469.  Lack  of  unity  in  our  system. — In  addition  to 
the  7000  national  banks  there  are  a  great  many  more 
state  banks  and  trust  companies,  which  are  not  only 
direct  competitors  of  the  national  banks  but  which  are 
governed  by  different  laws  and  regulations.     The  result 
is  obviously  a  mechanism  with  15,000  managers,  each 
interested  in  the  welfare  of  his  own  institution.     A  sys- 
tem must  be  devised  which  will  enable  the  banks  to  work 
in  unison  instead  of  at  cross  purposes  with  each  other 
and  which  will  render  possible  the  issue  and  redemption 
of  notes  as  the  need  for  them  appears  and  passes. 

470.  Savings  banks. — A  discussion  of  the   present 
conditions  of  banking  in  the  United  States  is  not  com- 
plete without  reference  to  savings  banks.     The  regula- 
tion of  these  institutions  has,  for  the  most  part,  been 
left  to  the  states,  and  in  most  cases  the  states  have  failed 
to  pass  effective  legislation.     The  savings  bank  is  the 
bank  of  the  wage  earner  whose  accumulations  are  worthy 
of  the  most  careful  protection.     In  the  aggregate  they 
already  amount  to  a  fabulous  sum,  and  the  system  is 
only  in  its  infancy.     The  mutual  savings  bank  laws  of 
New  England  and  New  York  are  the  most  perfect. 
In  these  banks  there  are  no  stockholders,  the  profits 
being  distributed  entirely  among  the  depositors.     Their 
investments  are  restricted  to  the  very  highest  class  of 
bonds  and  mortgages,  and  their  affairs  are  administered 
by  men  of  ability  and  public  spirit  who  serve  without 
compensation.     In  the  West  practically  all  the  savings 


378  MONEY  AND  BANKING 

banks  are  organized  for  profit  and  no  careful  regula- 
tion of  investments  is  attempted. 

471.  Postal  savings  banks. — It  is  this  situation  which 
has  given  rise  to  the  demand  for  postal  savings  banks — 
banks  managed  by  the  government  through  the  medium 
of  the  post  office  department.     It  has  been  proposed 
that  money  be  received  on  deposit  at  all  post  offices  and 
that  a  low  rate  of  interest,  probably  2  per  cent,  be  paid. 
The  postal  savings  bank  is  hardly  needed  in  New  Eng- 
land, but  there  is  great  need  either  for  its  establishment 
in  the  West  or  for  more  effective  regulations  of  the  ex- 
isting institutions  there. 

It  is  probable  that  the  establishment  of  a  postal  sav- 
ings bank  would  bring  out  of  hiding  a  considerable 
amount  of  gold  which  is  being  hoarded  by  ignorant  per- 
sons, and  that  money  withdrawn  from  other  banks  dur- 
ing panics  by  persons  who  feared  their  insolvency  would 
be  deposited  with  the  government  banks  and  thus  find 
its  way  back  into  circulation.  This  would  necessitate, 
of  course,  a  provision  authorizing  the  government  to 
deposit  money  so  obtained  in  the  national  banks;  and 
if  a  system  were  established  on  this  basis  it  should  prove 
to  be  of  great  benefit.  At  present  it  is  being  denounced 
by  the  existing  banks  largely  for  selfish  and  short- 
sighted reasons.  The  postal  bank  would  not  compete 
directly  with  carefully  regulated  savings  banks  because 
of  the  low  rate  of  interest  that  would  be  paid  and  be- 
cause it  would  not  offer  the  same  banking  facilities. 
It  would,  however,  cater  to  a  class  which  at  present 
does  not  deposit  its  money  at  all  and  to  persons  in  iso- 
lated communities  where  there  are  no  banking  facilities. 

472.  Guarantee  of  bank  deposits. — There  is  another 
movement  on  foot  in  regard  to  the  regulation  of  bank- 
ing which  is  worthy;  of  note,  namely,  the  guarantee  of 


PRESENT  CONDITIONS  OF  BANKING         379 

bank  deposits  by  the  government  or  by  the  states.  It 
was  a  prominent  plank  in  the  Democratic  platform  of 
1908  and  is  now  in  operation  in  Oklahoma.  Bank 
failures  and  losses  to  the  depositors  resulting  therefrom 
have  been  so  small  in  the  past  that  it  is  estimated  that 
a  small  assessment  on  each  bank  would  create  a  fund 
large  enough  to  pay  the  depositors  of  all  insolvent  banks. 
In  this  way  confidence  in  the  banks  would  be  implicit 
and  they  would  not  become  subject  to  "runs." 

The  plan  has  been  vigorously  attacked,  however,  by 
the  banks.  Their  position  is  substantially  that  the  sys- 
tem would  place  a  premium  upon  incompetent  and  dis- 
honest banking,  and  under  present  conditions  there  is 
little  doubt  of  the  correctness  of  the  contention.  The 
strong  bank  must  be  taxed  to  pay  the  depositors  of  the 
failed  bank,  and  at  the  same  time  it  would  lose  the  pres- 
tige that  results  from  its  strength.  Depositors  would 
pay  little  attention  under  such  a  system  to  the  stability  of 
a  bank,  because  their  deposits  would  be  secure  in  any 
bank  they  might  select.  They  would  be  governed 
largely  by  the  inducements  offered  by  the  various  banks, 
and  in  spite  of  strict  regulation  of  these  inducements 
it  would  be  very  difficult  to  keep  them  from  being  made 
without  the  knowledge  of  the  authorities.  The  inevita- 
ble result  would  be  the  establishment  of  many  new 
banks,  expansion  of  credit,  speculation,  and  finally, 
collapse. 

The  advocates  of  the  plan  claim  that  these  conditions 
can  be  prevented  by  frequent  and  searching  examina- 
tions. This  position  is  correct  only  if  such  examinations 
are  possible.  And  it  has  been  the  experience  of  the 
country  that  they  are  not.  Many  banks  have  failed 
only  to  have  the  receivers  discover  that  they  have  been 
insolvent  for  years  without  the  knowledge  of  the  author- 


580  MONEY  AND  BANKING 

ities  who  have  examined  them.  This  would  be  particu- 
larly true  if  a  national  system  of  guarantee  were 
adopted  to  cover  15,000  banks  operating  under  different 
conditions.  Whether  or  not  effective  examination  is 
possible  in  a  single  state  where  banking  conditions  are 
uniform  will  be  seen  in  the  experience  of  Oklahoma; 
and  upon  the  effectiveness  of  the  examination  and  regu- 
lation depends  the  success  of  the  system.  It  will  be 
watched  with  great  interest  because,  if  it  proves  practi- 
cable, it  will  be  generally  adopted  as  a  great  advance 
in  the  science  of  banking. 


CHAPTER  XXVII 

RELATION  OF  BANKS  TO  WALL  STREET 

473.  Market  for  securities  in  the  United  States. — 
New  Ycrk  City  is  the  central  market  of  the  United 
States  for  securities  just  as  London  is  of  the  whole 
world.  The  term  Wall  Street,  by  which  is  meant  the 
financial  center  in  New  York,  is  synonymous  with  mar- 
kets for  stocks  and  bonds.  Whenever  the  capital  re- 
quirements of  an  enterprise  are  too  large  for  the  local 
capitalists  to  handle  it  is  the  custom  for  promoters  to 
finance  their  proposition  in  New  York.  Capitalists 
with  funds  for  investment  and  an  enterprise  needing 
those  funds  are  brought  together  by  the  financial  insti- 
tutions of  Wall  Street.  The  business  of  bringing  the 
capitalists  and  the  enterprise  together  is  very  compli- 
cated and  may  require  a  long  time.  In  fact,  a  large 
proportion  of  the  securities  floated  in  Wall  Street  re- 
main there  in  the  hands  of  the  speculators. 

When  a  corporation  wishes  to  raise  capital  it  may 
issue  either  stocks  or  bonds.  In  order  to  dispose  of  its 
stocks  and  bonds  to  the  capitalists  it  is  necessary  that  a 
market  be  made  for  them.  When  the  United  States 
Steel  Corporation  was  organized  in  1901  the  problem 
of  disposing  of  the  vast  amount  of  stocks  of  that  cor- 
poration was  an  exceedingly  formidable  one.  The  task 
of  getting  the  public  interested  was  entrusted  to  one  of 
the  shrewdest  stock  market  manipulators  on  the  ex- 
change. So  successfully  did  Mr.  Keane  manipulate  the 
market  for  both  common  and  preferred  shares  that  the 

381 


382  MONEY  AND  BANKING 

public,  speculators  and  investors  were  induced  to  buy 
large  blocks  of  these  securities. 

There  is  a  great  deal  of  similarity  between  the  mar- 
ket for  securities  and  the  market  for  any  other  com- 
modity. The  interval  between  the  issue  of  the  securities 
and  the  moment  when  they  reach  the  ultimate  investor 
who  puts  them  away  in  his  strong  box  for  the  sake  of 
the  income  which  they  earn,  requires  the  use  of  circulat- 
ing capital,  just  as  a  merchant  handling  dry  goods  must 
provide  sufficient  capital  to  carry  his  stock  of  goods  on 
an  average  of  from  three  to  six  months. 

474.  Working  capital  of  dealers  in  securities. — The 
middlemen  who  carry  the  securities  in  Wall  Street  be- 
fore they  reach  the  ultimate  investor  need  in  their  busi- 
ness enormous  sums  of  temporary  capital.  These  mid- 
dlemen are  the  bond  houses  and  the  speculators.  The 
capital  required  is  largely  furnished  by  banks,  nearly  all 
of  it  in  the  form  of  bank  credit.  The  corporations  which 
issue  the  securities  are  paid  for  them  as  soon  as  they 
pass  into  the  hands  of  the  middlemen.  The  middleman 
will  probably  pay  for  them  with  a  check  which  the  cor- 
poration can  deposit  and  against  which  it  can  draw  its 
own  checks  in  making  payments ;  these  checks  drawn  by 
the  corporation  are  probably  deposited  again,  and  so  on 
indefinitely.  This  bank  credit  which  the  corporation  re- 
ceives for  its  issues  of  securities  serves  the  purpose  of 
the  corporation  in  producing  whatever  capital  goods  it 
needs. 

The  middlemen,  either  bond  houses  or  speculators, 
who  purchase  the  securities,  borrow  the  bulk  of  the  bank 
credit  they  require  from  the  banks.  The  banks  making 
a  specialty  of  loaning  credit  for  this  purpose  are  known 
as  Wall  Street  or  financial  banks.  The  credit  loaned 
to  the  speculators  or  bond  houses  is  based  on  collateral 


RELATION  OF  BANKS  TO  WALL  STREET   383 

security.     This  collateral  security  is  the  same  stocks  and 
bonds  which  the  credit  paid  for. 

475.  Details  of  the  collateral  loan. — We  have  dis- 
cussed, in  the  chapter  on  loans,  the  nature  of  the  collat- 
eral or  call  loan.     The  volume  or  amount  of  this  particu- 
lar business  is  so  enormous  that  it  is  worth  while  to  ex- 
amine more  closely  its  details.     Suppose,  for  example, 
that  a  speculator  buys  100  shares  of  Union  Pacific  com- 
mon stock  at  195.     This  quotation  means  that  the  100 
shares  of  Union  Pacific  stock  are  worth  195  per  cent  of 
par,  which  is  nearly  always  $100.     Therefore  the  100 
shares  will  cost  the  speculator  $19,500.     The  stock  will 
be  purchased  through  the  broker,  and  if  the  purchaser  is 
a  speculator  and  not  an  investor  it  is  quite  likely  it  will 
be  purchased  "on  margin."     The  customer  deposits  with 
the  broker  from  10  per  cent  to  20  per  cent  of  the  value 
of  the  stock  in  order  to  protect  the  broker  against  any 
loss  should  the  value  decline. 

The  rules  of  the  New  York  Stock  Exchange  require 
that  every  purchase  and  sale  must  be  bona  fide  and  that 
actual  delivery  of  the  stock  must  be  made.  The  broker 
is  not  in  possession  of  enough  capital  to  pay  for  the 
stocks  purchased  on  margin  by  his  customers  and  must 
go  to  the  bank  for  accommodation.  The  broker  pays 
for  the  shares  by  drawing  a  check  on  the  bank  with 
which  he  is  in  the  habit  of  doing  business,  and  by  having 
it  certified.  The  bank  will  loan  on  collateral  like  Union 
Pacific  probably  80  per  cent  of  its  market  value,  which 
gives  the  bank  a  margin  of  20  per  cent  in  case  there  is 
a  break  in  the  price.  The  balance  of  the  purchase  price 
is  made  up  by  the  margin  of  the  customer  and  the  capital 
of  the  broker. 

476.  Certification. — It  is  quite  likely  that  at  the  time 
the  broker  asks  for  the  certification  of  the  check  he  has 


384  MONEY  AND  BANKING 

not  sufficient  funds  in  the  bank  to  cover,  nor  can  he 
hypothecate  the  stock  until  he  has  paid  for  it.  The 
bank,  however,  readily  certifies  the  check,  depending 
upon  the  receipt  of  the  collateral  and  the  granting  of  a 
demand  loan  within  a  few  hours. 

This  is  over-certification  and  is  forbidden  by  the  Na- 
tional Bank  Act,  which  says  that  no  national  bank  may 
certify  a  check  unless  the  drawer  has  on  deposit  a  sum  of 
money  equal  to  the  amount  of  the  check.  In  Wall 
Street  this  law  is  generally  disregarded.  Usually  the 
banks  protect  themselves  against  technical  violation  by 
giving  the  brokers  credit  for  certain  sums  for  the  day, 
accepting  a  note  in  the  morning  for  it.  These  notes  are 
called  "day  notes."  No  interest  is  charged  on  the  credit 
extended,  because  the  brokers  are  constantly  depositing 
checks  as  well  as  drawing  them.  The  extent  of  this  bus- 
iness of  certifying  brokers'  checks  is  apparent  from  the 
figures  for  the  year  ending  October  1,  1906,  which  total 
up  to  the  enormous  amount  of  $24,500,000,000. 

477.  Restrictions  on  collateral. — Most  of  the  banks 
are  reluctant  to  take  too  much  of  any  one  security  as  col- 
lateral, and  it  may  be  necessary  for  the  broker  to  have 
several  bank  connections  so  that  he  can  distribute  the 
shares  among  them.     Usually  the  banks  will  not  take 
industrial  shares  alone  but  require  an  admixture  of  rail- 
road shares.     Furthermore,  only  those  securities  which 
have  a  ready  market  will  be  used  as  collateral  on  demand 
loans. 

478.  Call  loan  rate. — The  rate  of  interest  charged  on 
these  demand  loans  is  exceedingly  variable,  running  all 
the  way  from  1  per  cent  to  186  per  cent  per  annum.     If 
during  the  course  of  the  loan  there  should  be  a  sharp 
advance  in  money  rates  the  borrower  is  notified  that  the 
rate  charged  will  be  advanced.     If  the  broker  objects 


RELATION  OF  BANKS  TO  WALL  STREET      385 

to  the  advance  he  is  at  liberty  to  pay  the  loan  and  seek 
accommodation  elsewhere.  Conversely,  if  the  rate  goes 
down  he  may  claim  a  reduction  from  the  bank. 

479.  Responsibilities  of  the  loan  clerk. — All  collateral 
loans  are  in  charge  of  a  loan  clerk.     In  the  great  Wall 
Street  banks  this  is  a  most  responsible  position  requiring 
keen  and  constant  vigilance.     The  loan  clerk  must  keep 
a  sharp  watch  of  the  market  and  he  must  know  what  the 
money  market  is  doing.     He  must  keep  an  eye  con- 
stantly on  the  ticker  (as  the  instrument  for  reporting 
quotations  of  securities  is  called),  in  order  to  see  that 
the  margin  of  all  the  collateral  loans  of  which  he  has 
charge,  is  properly  kept.     If  there  is  a  sudden  slump 
in  the  market,  if  the  value  of  a  collateral  goes  down 
and  the  margin  is  not  maintained,  he  sends  immediate 
notice  to  the  borrower  for  more  collateral. 

There  are  certain  periods  when  the  investors  have 
gone  out  in  the  market  and  paid  for  a  large  pro- 
portion of  the  securities.  Such  was  the  case  in  1897 
before  the  boom  began  under  the  McKinley  Adminis- 
tration. The  banks  were  carrying  a  very  small  amount 
of  collateral  and  the  rates  were  very  low. 

480.  Undigested  securities. — In  a  few  years  the  con- 
dition changed  entirely.     The  floatations  of  hundreds 
of  industrial  combinations  in  the  period  from  1898  to 
1903  brought  into  the  market  an  enormous  quantity 
of  new  securities.     In  fact  the  issues  were  so  fast  that 
the  banks  were  soon  filled  up  to  their  limit  with  collateral 
loans.     The  Wall  Street  banks  were  furnishing  the  cir- 
culating capital  on  which  the  new  corporations  were  do- 
ing business.     The  stocks  and  bonds  thus  held  by  the 
banks  were  called  "undigested  securities."     The  phrase 
is  a  happy  one  expressing  as  it  does  the  stoppage  in 
the  regular  process  of  passing  the  securities  along  to 

VII— 25 


386  MONEY  AND  BANKING 

the  ultimate  investor.  The  securities  which  thus  failed 
to  move  naturally  were  the  cause  of  a  serious  disturb- 
ance in  the  financial  mechanism.  The  banks  found  that 
they  had  extended  their  credit  to  the  utmost  and  were 
unable  to  provide  sufficient  funds  for  industrial  pur- 
poses. 

The  condition  was  remedied  by  the  crisis  of  1903  which 
is  called  the  "rich  man's"  panic.  Prices  began  to  de- 
cline when  the  banks  began  to  sell  out  the  collateral  of 
weak  holders  who  were  unable  to  furnish  additional  mar- 
gin. The  cumulative  effect  of  these  forced  sales  caused 
a  very  sharp  break  in  prices,  which  tempted  the  investor 
to  enter  the  market  and  take  away  the  securities,  thus 
restoring  the  market  to  its  normal  condition  and  get- 
ting it  ready  for  the  great  boom  which  culminated  in 
1907. 

481.  Close  relation  between  reserves  and  prices. — The 
credit  which  the  financial  bankers  of  Wall  Street  extend 
to  the  dealers  and  speculators  in  securities  is  based  upon 
cash  reserves.  The  National  Bank  Act,  by  permitting 
the  interior  banks  to  deposit  half  or  three-fifths  of  their 
cash  in  the  reserve  city  banks  and  still  count  it  as  re- 
serve, encourages  the  piling  up  of  cash  in  these  central 
markets.  This  process  is  known  as  "pyramiding"  the 
reserve.  The  danger  of  this  method  lies  in  the  insta- 
bility of  this  cash  reserve,  which  sustains  the  credit 
structure  of  Wall  Street.  Whenever  from  any  cause 
the  interior  banks  withdraw  their  cash  deposit  the  New 
York  banks  are  forced  to  contract  their  credit,  which 
means  that  they  must  call  some  of  their  demand  loans. 
Some  of  the  speculators  will  be  unable  to  carry  their 
stock  and  must  sell  at  whatever  price  they  can  get. 
So  close  is  the  relation  between  all  kinds  of  business 
in  this  country  that  a  break  in  the  stock  market  from  the 


RELATION  OF  BANKS  TO  WALL  STREET   387 

causes  mentioned  above  is  likely  to  have  a  very  depress- 
ing effect  throughout  the  whole  country.  All  of  the 
periods  of  depression  which  this  country  has  experi- 
enced have  been  initiated  by  a  panic  in  Wall  Street. 

After  the  panic  of  1907  a  great  many  people  charged 
the  trouble  to  the  law  permitting  the  pyramiding  of  re- 
serves. The  withdrawal  of  these  reserves  was  obviously 
the  immediate  cause  of  the  panic.  The  advantages, 
however,  of  the  re-depositing  of  reserves  in  economiz- 
ing the  use  of  cash  are  so  many  that  it  would  probably 
be  wiser  to  regulate  than  to  abolish  the  system. 

482.  Plan  for  remedying  the  danger  in  redepositing 
reserves. — In  a  recent  article  the  author  suggested  that 
the  danger  of  pyramiding  might  be  largely  eliminated 
by  dividing  the  banks  in  New  York  City  into  two 
classes,  commercial  and  financial. 

Commercial  banks  furnish  credit  to  merchants  and 
manufacturers  to  be  used  in  the  production  and  move- 
ment of  goods;  the  financial  banks  furnish  credit  to 
brokers  and  dealers  to  be  used  in  purchasing  and  hold- 
ing securities  which  are  deposited  as  collateral  for  the 
loans.  The  distinguishing  feature  of  the  financial  bank 
is  the  collateral  loan.  This  fact  suggests  a  plan  for 
restricting  the  resources  of  the  speculator  without  at 
the  same  time  placing  any  burden  upon  industry  and 
commerce. 

483.  Commercial  banks. — Let  the  national  banks  in 
the  three  central  reserve  cities — New  York,  Chicago,  and 
St.  Louis — be  divided  into  the  two  classes,  commercial 
and  financial.     Leave  to  the  commercial  national  banks 
all  the  privileges  they  now  enjoy  under  the  National 
Bank  Act  (except  such  as  hereinafter  stated),  and  in 
addition  permit  them  to  exercise  trust  company  func- 
tions, such  as  acting  as  trustee,  administrator,  registrar, 


388  MONEY  AND  BANKING 

etc.;  also  give  them  authority  to  have  savings  depart- 
ments under  strict  savings  bank  laws.  This  concession 
should  be  granted  to  better  enable  them  to  compete 
with  the  state  banks  and  trust  companies.  No  commer- 
cial bank  should  be  allowed  to  make  any  loan,  or  to 
discount  any  commercial  paper  for  any  broker  or  any 
loan  secured  by  the  deposit  of  stocks  or  bonds,  unless 
such  collateral  is  taken  to  secure  a  loan  already  made, 
or  one  the  proceeds  of  which  are  not  to  be  used  in  trad- 
ing upon  an  exchange.  Violations  of  this  prohibition 
will  cause  the  bank  to  be  classified  as  a  financial  bank. 

484.  Financial  banks. — A  financial  bank  should  have 
the  right  to  make  loans  to  brokers  upon  collateral  se- 
curity of  stocks  and  bonds  or  warehouse  receipts.  How- 
ever, they  should  not  be  permitted  to  receive  deposits 
from  any  other  bank  or  banker  or  from  any  trust  com- 
pany. They  should  not  be  permitted  to  issue  circula- 
tion, but  should  have  the  right  to  deal  in  bonds  and 
underwrite  issues  of  bonds.  Every  loan  made  should 
be  posted  in  a  public  place  and  give  the  name  of  the 
borrower,  the  amount,  the  rate  of  discount,  and  the 
name  of  the  security. 

No  national  bank  should  deposit  any  of  its  funds  in 
any  other  institution  except  a  commercial  national  bank 
in  a  central  reserve  city  or  in  a  national  bank  in  another 
city. 

The  foregoing  provisions  are  an  attempt  to  deal  with 
speculation  on  the  basis  of  present  banking  laws.  It 
is  to  be  hoped  that  in  the  near  future  all  the  banks  of 
the  country  may  be  incorporated  and  regulated  under 
one  system.  Financial  conditions  can  never  be  thor- 
oughly controlled,  nor  can  the  speculative  expansion 
of  credit  and  prices  be  eliminated,  until  the  state  banks 
and  trust  companies  are  made  to  conform  to  the  re- 


RELATION  OF  BANKS  TO  WALL  STREET   389 

quirements  laid  down  for  national  banks.  It  is  a  great 
anomaly  to  put  strict  limitations  upon  the  national  banks 
and  expect  them  to  compete  with  unregulated  trust 
companies;  hence,  in  the  provisions  above,  we  have 
granted  to  the  commercial  national  banks  the  functions 
of  trust  companies.  It  were  much  better,  though,  to 
deprive  the  trust  companies  of  banking  functions,  which 
they  have  acquired,  by  usurpation,  until  the  states 
recognize  them  by  statute.1 

i  Banker's  Magazine,  Aug.,  1909,  p.  192. 


CHAPTER  XXVIII 

BANKS  AND  THE  UNITED  STATES  TREASURY 

485.  Responsibility  of  the  Secretary  of  the  Treasury. 
— Few  people  have  any  adequate  idea  of  the  power  and 
responsibility  attaching  to  the  position  of  Secretary  of 
the  United  States  Treasury.  This  power  and  respon- 
sibility was  not  consciously  given  to  the  head  of  the 
department  but  exists  by  reason  of  the  failure  of  Con- 
gress to  assume  a  burden  and  responsibility  which  prop- 
erly belongs  to  it.  Congress,  ordinarily  so  eager  to  have 
a  hand  in  every  question  of  importance  and  so  jealous 
of  its  prerogative,  has  in  this  case  backed  away  timidly 
from  the  problem,  leaving  the  Secretary  to  grapple 
with  it  as  best  he  can,  handicapped  as  he  is  all  the  while 
by  notoriously  inadequate  legislation  and  compelled  to 
take  advantage  of  every  little  technicality  and  am- 
biguity of  the  statutes  in  order  to  save  the  country  from 
constantly  threatening  panics. 

The  average  Congressman  may  know  something 
about  the  silver  question  (he  had  to  learn  that  when 
the  matter  was  the  paramount  political  issue  in  1896), 
but  having  gone  so  far  he  would  be  only  too  willing, 
if  it  were  possible,  to  regard  as  settled  the  whole  intri- 
cate and  perplexing  subject  of  currency  and  finance. 
He  realizes  that  it  is  a  "live"  wire  and  that  when  it 
sputters  the  appropriate  thing  for  him  to  do  is  to  run. 
Somebody,  however,  must  take  charge  of  the  situation 
and  face  the  danger  of  a  shock.  In  the  case  of  the 

390 


BANKS  AND  UNITED  STATES  TREASURY.     391 

currency  problem  that  man  is  the  Secretary;  of  the 
Treasury. 

The  situation  which  confronts  the  Secretary  is  this: 
The  Government  is  the  largest  financial  institution  in 
the  country,  its  receipts  and  disbursements  together 
amounting  to  four  or  five  millions  of  dollars  daily.  A 
large  part  of  these  transactions  is  made  in  cash,  and 
the  daily  balance  due  from  or  to  the  New  York  Clear- 
ing House  must  be  settled  in  cash.  It  may  readily  be 
seen  that  when  the  receipts  happen  to  be  greatly  in  ex- 
cess of  the  disbursements,  the  Treasury  and  Sub-Treas- 
ury will  have  on  hand  a  large  surplus  of  idle  currency 
which  has  been  withdrawn  from  circulation  and  from 
the  reserves  of  the  banks. 

486.  Treasury  causes  stringencies. — There  is  a  cer- 
tain quantity  of  currency  in  the  country,  consisting  of 
the  various  government  issues  and  national  bank  notes. 
Its  amount  can  be  increased  or  diminished  but  slowly. 
The  larger  percentage  of  it  lies  in  the  Treasury;  part 
is  in  the  bank  vaults  serving  as  the  basis  for  credit; 
the  remainder  is  in  the  pockets  of  the  people.  Should 
anything  happen  to  increase  the  amount  in  use  by  the 
people,  it  must  come  either  from  the  bank  reserves  or 
from  the  Treasury ;  if  an  unusually  large  amount  flows 
to  the  Treasury  and  is  not  disbursed  then  the  amount 
in  the  banks  or  in  circulation  is  reduced  by  that  much. 
During  the  past  few  years  it  has  frequently  happened 
in  the  autumn  season  that  both  the  amount  demanded 
for  circulation  and  the  amount  lodged  in  the  Treasury 
have  increased  suddenly  at  the  expense  of  the  bank  re- 
serves, especially  those  of  New  York  City,  causing  an 
acute  monetary  stringency. 

The  great  bulk  of  the  exchanges  of  the  country  is 


392  MONEY  AND  BANKING 

made  by  means  of  credit  rather  than  currency.  How- 
ever, the  amount  of  credit  available  for  this  use  is  rig- 
idly limited  by  the  amount  of  currency  which  may  be 
employed  in  bank  reserves.  If  the  banking  credit  of 
the  country  is  expanded  to  the  limit  permitted  by  law 
and  a  portion  of  the  reserve  funds  is  suddenly  taken 
away,  the  banks  must  contract  credit  accordingly,  hence 
the  immense  importance  of  the  weekly  statement  of 
the  New  York  Clearing  House  banks  showing  the  con- 
dition of  their  reserve.  A  contraction  of  credit  means 
a  diminution  of  purchasing  power  and  a  weakening 
demand  for  everything  that  is  bought  and  sold,  stocks 
and  bonds  being  especially  sensitive  to  this  influence. 
A  sudden  withdrawal  of  cash  funds  from  the  New 
York  banks  and  the  immediate  contraction  of  credit 
which  follows  when  credit  is  expanded,  is  likely  at  any 
time  to  become  the  initial  cause  of  a  panic  which  might 
spread  outward  from  Wall  Street  until  it  involves  the 
whole  country. 

The  Secretary  of  the  Treasury  is  required  to  keep 
in  the  Treasury  or  Sub-Treasuries  all  the  cash  received 
by  the  government,  except  the  receipts  from  internal 
revenue,  amounting  to  about  $1,000,000  a  day,  which, 
before  they  are  "covered"  into  the  Treasury,  may  be 
deposited  in  certain  banks  designated  as  United  States 
depositories.  As  security  for  these  the  banks  must  de- 
posit with  the  Secretary  of  the  Treasury  United  States 
bonds  to  the  full  value  of  the  deposit,  or  other  bonds 
at  the  discretion  of  the  Secretary. 

This,  then,  is  the  situation.  The  prosperity  of  the 
country  depends  to  a  large  extent  on  the  conditions  in 
the  financial  center.  Healthy  financial  conditions  de- 
mand stability  in  the  amount  of  credit  available  for  use 
in  the  markets;  an  increase  leads  to  speculation,  while 


BANKS  AND  UNITED  STATES  TREASURY      390 

a  decrease  may  lead  to  dangerous  panics.  In  a  word, 
the  whole  of  our  industrial  and  financial  life  rests  upon 
the  foundation  of  cash  in  the  New  York  bank  reserves. 
There  are  two  ways  by  which  this  cash  reserve  may  be 
interfered  with — by  withdrawals  and  shipments  West 
and  South  during  the  autumn  season  when  those  sec- 
tions need  an  unusual  quantity  of  cash  money;  and  by 
the  piling  up  of  surplus  funds  in  the  Treasury.  By 
whichever  manner  the  funds  are  withdrawn  the  effect 
is  the  same. 

487.  Defective  currency  laws. — The  condition  above 
outlined  is  not  inevitable  but  is  the  unavoidable  conse- 
quence of  our  currency  and  the  treasury  laws.     We 
know  that  the  system  gives  rise  to  grave  dangers  which 
threaten  the  happiness  and  well  being  of  every  person 
in  the  country.     Congress  refuses  to  change  the  law 
and  the  law  is  incapable  of  meeting  the  conditions  as 
they  arise.     The  bankers  of  the  country,  particularly 
of  New  York,  are  often  loudly  blamed  because  they 
allow  such  conditions  to  arise  and  exist,  but  among  so 
many,  who  is  there  to  take  the  responsibility  or  has 
sufficient  power  to  remedy  the  matter?     The  banker  is 
conducting  a  private  business  for  private  gain  and  there 
is  no  reason  why  he  should  be  expected  to  assume  a  pub- 
lic function  of  such  magnitude. 

488.  Expedients  of  the  secretary. — The  responsibil- 
ity falls,  therefore,  upon  the  Secretary  of  the  Treasury. 
He  is  given  specific  discretionary  powers  in  enforcing 
the  laws  and  out  of  these  certain  expedients  have  been 
devised  which  may  be  used  under  certain  conditions : 

1.  The  secretary  has  induced  national  banks  in  one 
way  or  another  to  take  out  notes  in  advance  of  their 
actual  needs. 

2.  He  has  anticipated  the  payment  of  interest  on 


394  MONEY  AND  BANKING 

United  States  bonds  in  order  to  put  cash  into  circu- 
lation. 

3.  He  has  made  purchases  of  United  States  bonds 
for  the  same  purpose. 

4.  He  has  made  a  ruling  that  the  banks  need  not 
keep  a  reserve  against  government  deposits.     The  New 
York  Clearing  House  Association,  however,  continues 
to  enforce  its  reserve  requirements  against  members,  so 
that  the  effect  of  the  ruling,  so  far  as  it  concerns  the 
New  York  banks,  is  nullified. 

5.  He  has  allowed  the  government  depository  banks 
to  substitute  county,  city,  state,  and  other  bonds,  in- 
cluding, it  is  understood,  some  railway  bonds,  in  the 
place  of  United  States  bonds  as  security  for  public  de- 
posits.    This  privilege  was  extended  only  to  such  banks 
as  would  agree  to  use  the  United  States  bonds  thus 
released  for  taking  out  additional  circulation. 

6.  He  has  warned  the  depository  banks  to  abstain 
from  using  their  funds  in  Wall  Street  as  a  basis  for  call 
loans  to  speculators  through  brokers. 

7.  He  has  entered  into  the  foreign  exchange  market 
to  assist  the  gold  importing  movement  by  giving  the 
banks  temporary  deposits  of  gold  equal  to  the  amount 
they  engage  for  import  from  abroad.     This  removes 
the  advantage  under  which  our  importing  bankers  labor 
— that  of  losing  interest  during  the  time  the  gold  is  in 
transit — and  to  a  considerable  extent  stimulates  gold 
imports. 


CHAPTER  XXIX 

EUROPEAN  BANKING  SYSTEMS 

489.  Bank  of  England.— The  Bank  of  England 
owes  its  origin  to  conditions  similar  to  those  which  ob- 
tained in  the  United  States  when  the  Bank  of  North 
America  was  founded.  It  was  established  in  1694  for  the 
purpose  chiefly  of  assisting  the  fiscal  operations  of 
the  government.  On  account  of  the  war  with  France 
the  government  was  badly  in  need  of  money.  Taxes 
of  all  sorts  had  been  levied  but  it  was  very  difficult  for 
the  government  to  borrow  because  of  the  confiscation 
in  1672  of  funds  borrowed  in  like  manner  by  Charles  II. 
Although  this  sum,  amounting  to  £1,300,000  had  finally 
been  paid,  bankers  and  individuals  of  wealth  were  still 
very  cautious  about  making  advances  to  the  govern- 
ment. 

The  original  charter  of  the  Bank  of  England  pro- 
vided that  it  should  be  given  the  power  to  issue  notes, 
to  deal  in  coin,  bullion,  and  commercial  bills,  and  to 
make  advances  on  goods  and  merchandise ;  these  powers 
being  contingent  upon  a  loan  to  the  government  of 
£1,200,000  for  which  the  bank  was  paid  8  per  cent  in- 
terest. From  its  ability  to  issue  notes  the  bank  found 
itself  in  possession  of  an  equal  amount  of  currency 
which  it  was  at  liberty  to  loan.  These  notes  were  not 
payable  to  bearer,  hence  passed  only  by  endorsement. 
They  were  payable  at  specified  dates  and  bore  interest. 
In  1697  the  capital  of  the  bank  was  increased,  a  further 
loan  made  to  the  government,  and  the  bank  was 

395 


396  MONEY  AND  BANKING 

given  the  right  to  issue  demand  notes  without  interest. 

In  1709  an  attempt  was  made  to  give  to  the  Bank  of 
England  a  monopoly  of  the  banking  business  by  pro- 
viding that  no  corporation  or  partnership  composed  of 
more  than  six  persons  should  be  given  the  power  to 
issue  circulating  notes.  The  issue  of  notes  at  that  time 
was  supposed  to  cover  the  entire  field  of  banking,  hence 
this  provision  was  understood  as  prohibiting  any  or- 
ganization of  more  than  six  persons  from  engaging 
in  banking  in  any  form.  It  is  obvious  that  this  did  not 
prohibit  the  issue  of  notes  by  individuals  or  corporations 
of  less  than  six  persons;  nor  did  it  prohibit  the  opera- 
tions of  banks  of  deposit  by  large  organizations.  This 
fact  was  not  understood  for  many  years,  however,  and 
with  the  exception  of  small  institutions  the  Bank  of 
England  enjoyed  a  monopoly  of  the  entire  field  of 
banking.  The  effect  of  this  monopoly  was  not  felt  at 
first,  but  with  the  general  development  of  commerce 
which  took  place  in  the  latter  part  of  the  eighteenth 
century  a  demand  for  credit  instruments  appeared 
which  the  Bank  of  England  could  not  meet.  There 
sprang  up  accordingly  a  vast  amount  of  small  but  weak 
banks,  whose  notes  soon  flooded  the  country.  They 
were  issued  for  the  most  part  in  small  amounts,  and  in 
1777  a  successful  attempt  was  made  to  drive  them  out 
of  circulation  by  prohibiting  the  issue  of  notes  in  de- 
nominations smaller  than  <£5. 

490.  Development  of  the  use  of  checks. — Mr.  Conant 
in  his  "History  of  Modern  Banks  of  Issue"  says: 

The  prohibition  upon  note  issues  was  probably  one  of  the 
causes  which  contributed  to  the  use  of  checks.  The  notes  issued 
by  private  bankers  were  at  first  written  on  paper  for  any  odd 
sum,  like  promissory  notes.  The  practice  was  introduced  by 


EUROPEAN  BANKING  SYSTEMS  397 

Child  &  Co.  in  1729  of  having  the  notes  partly  printed  and 
partly  written,  like  a  modern  check.  These  notes  continued 
to  be  issued  till  about  1793,  when  the  existing  system  was  intro- 
duced, of  giving  the  depositor  a  credit  for  the  full  amount  of  his 
deposit  and  authorizing  him  to  draw  checks  at  his  convenience 
against  it.  The  issue  of  notes  by  private  bankers  was  not 
forbidden  until  the  Bank  Act  of  1844,  but  their  use  gradually 
diminished  as  the  greater  convenience  of  checks  came  to  be  under- 
stood. 

The  intimate  relation  between  the  Bank  of  England 
and  the  government,  which  had  been  established  at  the 
outset,  continued  as  time  passed.  The  charter  was  re- 
newed from  time  to  time,  usually  on  the  condition  of 
additional  loans  to  the  government.  The  war  against 
Napoleon  was  financed  largely  by  the  Bank  of  Eng- 
land, Mr.  Pitt  drawing  heavily  upon  the  bank  for  money 
which  was  sent  to  the  Continent  to  promote  the  war. 
These  drains  of  specie  continued  unabated  until  the 
bank  was  forced  to  suspend  specie  payment  in  1797. 
The  suspension,  or  restriction  as  it  was  called,  continued 
until  1821. 

During  the  earlier  part  of  this  period  the  Bank  of 
England  was  able  to  keep  its  notes  circulating  at  par 
with  coin.  The  act  of  1797  had  made  them  legal  tender. 
Finally,  however,  depreciation  began,  and  during  the 
boom  which  followed  the  panic  of  1810  assumed  con- 
siderable proportions.  In  that  year  a  committee  was 
appointed  by  Parliament  to  investigate  the  financial 
and  monetary  situation,  and  a  report  known  as  the 
Bullion  Report  was  the  result.  In  this  report  the  real 
evils  of  the  situation  were  ably  expounded,  and  recom- 
mendations made  which  if  adopted  promptly  would  have 
restored  the  currency  to  a  stable  value.  It  served,  how- 


398  MONEY  AND  BANKING 

ever,  to  educate  the  minds  of  bankers  and  public  men 
to  an  understanding  of  the  problems  involved,  an  edu- 
cation which  bore  fruit  a  few  years  later. 

In  1821  Parliament  authorized  a  return  to  a  specie 
basis,  and  as  the  bank  had  already  accumulated  a  large 
mount  of  gold,  resumption  speedily  became  a  fact.  At 
the  same  time  the  government's  power  to  borrow  from 
the  bank  was  restricted  so  that  no  further  loans  could  be 
made  without  special  authority  from  Parliament. 

In  1823  it  was  discovered  that  the  Bank  of  England 
had  not  been  given  a  monopoly  of  banking  except  in 
its  note  issue  function.  There  followed  accordingly  a 
movement  to  establish  joint  stock  banks  of  deposit. 
This  had  little  direct  effect,  as  no  banks  were  immedi- 
ately established,  but  it  resulted  in  certain  concessions 
from  the  Bank  of  England.  In  1826  the  bank  con- 
sented to  the  establishment  of  joint  stock  banks  of  issue 
at  a  distance  of  more  than  sixty-five  miles  from  London. 
In  1883  joint  stock  banks  were  authorized  in  London 
and  vicinity  but  they  were  not  given  the  right  of  issue. 

In  1833  an  act  was  passed  by  Parliament  which  made 
the  notes  of  the  Bank  of  England  legal  tender  as  long 
as  they  were  being  redeemed  in  gold  at  the  bank.  The 
notes  had  been  legal  tender  prior  to  this  act  but  only 
during  the  restriction  period. 

491.  Bank  Act  of  1844. — During  the  years  which 
followed  the  establishment  of  joint  stock  banks  of  issue 
seventy-two  such  banks  were  organized  and  note  issues 
increased.  In  1836  and  again  in  1839  panics  occurred 
and  it  was  popularly  thought  that  they  were  caused  by 
an  excessive  issue  of  notes.  The  result  was  an  agitation 
which  terminated  in  the  Bank  Act  of  1844.  The  charter 
of  the  Bank  of  England  was  before  Parliament  for  re- 
newal. The  new  charter  provided  for  the  entire  sepa- 


EUROPEAN  BANKING  SYSTEMS  399 

ration  of  the  banking  and  issue  departments.  The 
bank  was  ordered  to  deposit  with  the  issue  department 
£14,000,000  of  government  securities,  which  repre- 
sented the  average  amount  of  circulation  then  outstand- 
ing. This  deposit  included  the  government's  debt  to 
the  bank,  which  amounted  to  £11,015,100.  In  return 
the  bank  received  an  equivalent  amount  of  notes. 
Further  notes  could  be  issued  only  after  a  deposit  of 
gold  coin  or  bullion  with  the  issue  department,  the  right 
of  deposit  being  open  to  anyone.  Joint  stock  banks 
of  issue  were  allowed  to  continue  issuing  notes,  but  if 
they  retired  their  circulation  it  could  not  again  be  issued. 
In  order  that  this  might  not  cause  a  contraction  of  the 
currency  the  Bank  of  England  was  given  the  right  to 
increase  its  deposit  of  bonds  and  the  notes  which  it 
would  obtain  for  them  to  the  amount  of  two-thirds  of 
the  circulation  retired  by  the  joint  stock  banks. 

By  this  act  the  character  of  the  bank  note  was 
changed  entirely.  Formerly  it  had  been  a  credit  in- 
strument, depending  for  its  current  redemption  upon 
the  reserve  of  the  bank  and  for  its  ultimate  redemption 
upon  the  bank's  general  assets,  the  bonds,  notes,  etc., 
for  which  it  had  been  exchanged.  Its  volume  ex- 
panded and  contracted  with  the  demand  for  medium  of 
exchange.  That  its  excessive  issue  could  have  caused 
the  panics  of  1836  and  1839  is  inconceivable.  The 
bank  act  converted  it  into  a  gold  certificate — a  mere 
warehouse  receipt  for  gold — destroying  entirely  its 
credit  character.  Its  volume  can  expand  now  only  after 
a  deposit  of  an  equivalent  amount  of  gold,  hence  the 
only  economy  the  system  attains  is  in  the  greater  con- 
venience of  paper  money. 

492.  Character  of  Bank  of  England  note. — The  bank 
act  was  followed  by  a  considerable  increase  of  deposit 


400  MONEY  AND  BANKING 

banking.  Hence  its  inelasticity  was  not  felt  until  the 
panic  of  1847.  In  that  year,  and  again  in  the  panics 
of  1857  and  1866,  the  demand  on  the  bank  for  notes 
was  so  great  that  the  government  suspended  the  bank 
act  and  allowed  the  bank  to  issue  notes  based  on  its 
general  assets.  The  rate  of  interest  at  which  the  bank 
could  loan  its  notes  was  fixed  in  1857  at  8  per  cent,  and 
in  1866  at  10  per  cent,  and  the  interest  was  to  be  credited 
to  the  government's  account,  so  that  the  bank  would  not 
increase  its  loans  unnecessarily  with  the  idea  of  making 
large  profits  for  itself.  In  this  suspension  system,  lies 
the  only  elasticity  of  the  English  plan  of  note  issue. 
It  has  had  the  desired  effect  in  the  panics  in  which  it 
has  been  used,  but  because  it  depends  upon  the  consent 
of  Parliament  it  is  a  dangerous  device  to  rely  upon. 

493.  The  Bank  of  England  private. — The  Bank  of 
England  has  always  remained  a  private  corporation, 
bent  upon  earning  profits  for  its  stockholders.  It  is 
managed,  however,  in  the  interests  of  the  whole  country, 
and  its  management  has  always  been  so  efficient  and 
unselfish  that  many  people  are  under  the  impression 
that  it  is  a  government  institution.  It  still  greatly  as- 
sists the  fiscal  operations  of  the  government  by  man- 
aging the  public  debt,  receiving  government  revenues, 
and  making  various  payments,  but  over  these  functions 
the  government  has  no  direct  control  except  when  its 
contracts  with  the  bank  expire. 

With  the  growth  of  deposit  banking,  the  resultant 
increase  of  joint  stock  banks  of  deposit  and  restriction 
upon  note  issue,  the  Bank  of  England  has  become 
chiefly  a  bankers'  bank.  It  is  not  governed  by  bankers 
but  bankers  are  its  customers.  In  fact  the  charter  pro- 
vides that  bankers  shall  not  be  elected  to  the  board  of 
directors,  and  the  board  is  composed  largely  of  mer- 


EUROPEAN  BANKING  SYSTEMS  401 

chants.  Its  chief  usefulness  to  bankers  is  as  a  depos- 
itory of  their  cash  reserves  and  as  a  bank  of  re-dis- 
count. 

There  are  no  laws  in  England  compelling  banks  to 
keep  cash  reserves,  their  size  being  left  entirely  to  the 
judgment  of  the  managers.  The  banks  throughout 
England  find  it  much  more  convenient  to  deposit  their 
cash  in  the  Bank  of  England.  No  interest  is  paid  on 
these  deposits  but  the  banks  continue  to  make  them  be- 
cause of  the  right  it  gives  them  to  draw  on  the  city 
banks.  The  result  of  this  system  of  concentrating  the 
cash  in  one  bank  is  to  place  upon  the  Bank  of  England 
the  responsibility  of  holding  the  cash  funds  of  the  entire 
country  not  in  active  circulation.  When  there  is  an 
extraordinary  demand  for  any  reason,  such  as  with- 
drawal of  deposits  by  individuals  and  firms  in  time  of 
panic,  that  demand  is  transmitted  from  one  bank  to 
another  until  it  finally  reaches  the  Bank  of  England. 
For  this  reason  the  Bank  of  England  must  keep  itself 
in  a  position  to  finance  such  occurrences,  and  it  does  so 
by  keeping  a  large  cash  reserve.  It  has  learned  from 
experience  that  a  40  per  cent  reserve  is  sufficient,  and 
this  it  aims  to  keep  at  all  times.  Its  device  for  keeping 
its  reserve  intact  is  the  discount  rate.  It  selects  the 
most  urgent  cases  for  relief  automatically  by  raising 
the  rate  at  which  it  will  discount  paper.  This  immedi- 
ately restricts  loans.  When  the  reserve  piles  up  in  ex- 
cess of  what  is  needed  the  bank  encourages  loans  by 
lowering  the  rate.  This  is  the  principle  upon  which 
loans  are  made  to  the  world  over,  but  because  of  the 
importance  of  the  Bank  of  England  its  discount  rate 
is  watched  carefully,  even  in  this  country,  as  a  barom- 
eter of  financial  conditions. 

494.  Banking  in  France. — The  earliest  attempt  to 

VII— 26 


402  MONEY  AND  BANKING 

establish  a  central  bank  of  issue  in  France  was  made 
by  John  Law  in  1716.  The  bank  was  well  conceived 
and  for  a  time  was  ably  managed,  but  it  finally  became 
involved  with  Law's  speculative  schemes  and  went  into 
liquidation  in  1721.  The  panic  which  marked  the  end 
of  Law's  career  was  so  severe  that  for  fifty  years  there 
was  no  further  attempt  to  establish  a  great  national 
bank.  In  1776  the  Bank  of  Commercial  Discount  was 
organized  only  to  receive  its  death  blow  at  the  hands 
of  the  government  in  1789.  During  its  brief  existence 
it  was  well  managed  and  gave  excellent  service.  The 
government,  however,  found  that  its  own  credit  was 
unstable,  and  in  an  effort  to  repair  it  dragged  the  bank 
down  with  it.  The  climax  occurred  when  the  govern- 
ment ordered  the  bank  to  pay  into  the  Treasury  a  large 
sum  in  notes  in  return  for  worthless  assignats.  In  1793 
the  bank  went  into  liquidation. 

495.  Bank  of  France. — The  Bank  of  France  was 
founded  by  Napoleon  in  1800  with  a  capital  of  30,000,- 
000  francs.  At  the  outset  it  had  no  special  privileges 
in  regard  of  the  issue  of  notes,  nor  was  it  a  government 
institution  in  any  sense.  In  1803  the  capital  was  raised 
to  45,000,000  francs,  and  it  was  given  the  exclusive 
right  of  issue  in  Paris.  In  1806  the  capital  was  further 
increased  to  90,000,000  francs  and  the  present  system  of 
government  was  adopted. 

Under  this  system  a  governor  and  two  deputy  gov- 
ernors are  appointed  by  the  state.  These  officials  must 
be  stockholders.  There  is  also  a  board  of  fifteen  re- 
gents chosen  by  the  stockholders,  but  the  governor  pre- 
sides over  this  board  and  has  general  supervision  of 
loans  and  all  bank  affairs. 

In  1808  the  bank  was  given  the  exclusive  right  of  note 
issue  in  all  towns  in  which  it  had  branches.  During 


EUROPEAN  BANKING  SYSTEMS  403 

the  years  following  the  fall  of  Napoleon  its  influence 
waned  somewhat  in  favor  of  the  establishment  of  de- 
partmental banks.  A  large  number  of  these  were  es- 
tablished between  1830  and  1840  as  the  result  of  the 
belief  that  the  Bank  of  France  was  not  properly  or- 
ganized to  administer  the  banking  affairs  of  the  average 
citizen.  It  was  popularly  believed  to  be  a  bankers' 
bank.  The  growth  of  the  departmental  banks  soon  re- 
sulted in  a  spirited  contest  with  the  Bank  of  France, 
the  main  point  at  issue  being  whether  the  privilege 
of  note  issue  should  be  confined  to  the  one  bank 
or  bestowed  upon  all.  The  final  result  was  the  Act 
of  1848  which  gave  to  the  Bank  of  France  a  monop- 
oly of  the  note  issue  function.  It  was  required,  how- 
ever, that  the  bank  should  buy  out  the  departmental 
banks  of  issue,  which  it  promptly  did  by  increasing  its 
own  capital  stock. 

496.  Deposit  currency  little  used. — The  monopoly  of 
the  note  issue  function  did  not  result  in  building  up 
great  banks  of  deposit  in  France  as  it  did  in  England. 
One  of  the  most  interesting  features  of  the  French 
system  is  the  undeveloped  condition  of  the  deposit  cur- 
rency.    Notes  are  used  almost  entirely  in  large  trans- 
actions as  well  as  in  the  channels  of  small  trade.     The 
confinement  of  the  privilege  of  note  issue  to  the  one 
great  institution  has  given  to  France  a  uniform,  stable 
currency  against  which  there  is  little  complaint  and  be- 
cause of  which  there  seems  to  be  no  necessity  for  the 
growth  of  deposit  banking. 

497.  Asset  currency. — The  notes  of  the  Bank  of 
France  are  issued  on  what  is  known  as  the  banking  or 
"asset  currency"  plan..    In  other  words,  there  is  no  spe- 
cific fund  set  aside  for  their  redemption,  such  as  is  pro- 
vided by  the  English  law  and  by  the  National  Bank  Act 


404  MONEY  AND  BANKING 

of  the  United  States.  The  volume  of  notes  outstanding 
is  fixed  solely  by  the  needs  of  business  and  by  the  cash 
reserves  which  the  bank  thinks  it  necessary  to  keep  to 
redeem  the  notes.  Under  this  plan  bank  notes  are 
treated  just  as  deposits  are  treated  in  national  banking 
law — as  demand  obligations  of  the  bank  against  the  re- 
demption of  which  a  reasonable  cash  reserve  should  be 
kept. 

In  practice  the  amount  of  notes  against  which  an 
equivalent  amount  of  cash  is  not  held  is  relatively  small. 
Although  the  Bank  of  France  is  not  required  to  pro- 
vide any  specific  reserve  it  has  found  it  advisable  to 
keep  a  very  large  one,  much  larger  than  we  consider 
necessary  in  this  country.  The  reserve  of  the  Bank  of 
France  will  average  about  60  per  cent  of  its  circulation 
in  gold  and  silver  coin. 

498.  Branches. — The  bank  is  required  to  maintain 
one  branch  in  every  department  in  France.  Each, 
branch  is  allotted  a  certain  amount  of  the  capital,  and 
the  law  requires  that  half  the  capital  shall  be  held 
locally.  The  total  capital  is  at  present  180,000,000 
francs,  or  approximately  $36,000,000.  Loans  are  made 
by  the  branches  as  well  as  at  the  central  institution, 
and  at  the  same  rate  of  interest.  It  is  worthy  of  note 
that  the  bank  often  loans  in  very  small  sums,  running 
down  to  a  few  francs.  The  bank  also  does  a  large 
amount  of  re-discounting,  the  small  institutions 
throughout  France  accepting  paper  with  the  intention 
of  passing  it  on  at  a  small  profit  to  the  central  bank. 

It  is  obvious  that  the  Bank  of  France  represents  a 
theory  of  banking  which  contrasts  strikingly  with  that 
upon  which  the  Bank  of  England  is  conducted.  The 
Bank  of  England  issues  notes  only  against  the  actual 
deposit  of  gold  with  the  issue  department;  the  Bank 


EUROPEAN  BANKING  SYSTEMS  405 

of  France  issues  them  without  any  restriction  whatever 
except  those  imposed  by  its  own  conservatism.  It  is 
evident  that  the  later  method,  although  it  may  not  ap- 
pear on  its  face  to  be  as  safe,  gives  to  the  currency  the 
much  needed  attribute  of  elasticity.  The  English  sys- 
tem is  notably  inelastic.  The  volume  of  outstanding 
notes  can  be  increased  only  by  the  purchase  and  deposit 
of  gold,  a  method  both  slow  and  expensive.  As  we 
have  seen,  the  rigidity  of  the  system  has  caused  the 
growth  of  the  deposit  currency,  the  bank  note  losing 
entirely  its  true  function  as  a  credit  instrument.  Eng- 
land's only  resource  in  time  of  acute  stringency  is  the 
suspension  of  the  bank  act,  which  in  itself  is  an  admis- 
sion that  the  system  is  incorrect  in  principle.  In  France 
unrestricted  issue  has  allowed  the  bank  note  to  retain 
its  true  character  and  its  importance  as  a  medium  of 
exchange.  The  system  is  elastic,  the  volume  of  the 
circulation  expanding  and  contracting  as  the  demand 
for  it  changes.  Although  there  are  no  reserve  require- 
ments the  same  result  has  been  accomplished  by  con- 
servative management,  so  that  the  note  of  the  Bank  of 
France  has  become  as  readily  acceptable  as  the  Bank 
of  England's  gold  certificate. 

The  question  as  to  which  is  the  better  system,  how- 
ever, cannot  be  considered  here  because  it  goes  far 
beneath  the  merits  of  the  two  plans  of  note  issue.  In 
final  analysis  it  would  be  found  to  depend  upon  which 
system — that  of  performing  exchanges  with  bank  notes 
or  with  the  deposit  currency — would  be  most  economical 
and  best  suited  to  the  needs  of  a  given  country.  Even 
then  final  decision  of  the  question  must  be  largely  of 
academic  value,  for  the  century-long  habits  of  nations 
cannot  be  readily  changed.  A  knowledge  of  the  under- 
lying principles,  however,  setting  forth  the  two  great 


406  MONEY  AND  BANKING 

schools  of  banking,  is  extremely  valuable  to  anyone  who 
is  interested  in  the  unsettled  banking  problems  of  the 
United  States.  France  and  England  have  each  given 
to  the  world  splendid  examples  of  conservative,  upright 
banking  which  stand  as  monuments  to  the  ability  of 
their  citizens  to  conduct  private  enterprises  in  the  inter- 
ests of  the  public  welfare. 

499.  Imperial  Bank   of   Germany. — The   Imperial 
Bank  of  Germany,  or  Reichsbank,  was  founded  in  1875. 
Its  organization  was  one  of  the  measures  adopted  by 
Bismarck  to  bring  order  out  of  the  monetary  chaos  that 
had  existed  in  the  German  states  prior  to  the  unification 
of  the  empire.     Together  with  other  monetary   and 
banking  reforms  it  was  made  possible  largely  by  the 
huge  war  indemnity  of  $1,000,000,000  which  Germany 
collected  from  France.     In  1873  the  gold  standard  was 
adopted,  and  the  mark  made  the  unit  of  value  in  place 
of  the  thaler. 

The  Imperial  Bank  was  organized  upon  the  founda- 
tions of  the  Bank  of  Prussia,  established  a  century 
earlier.  This  bank  was  owned  privately  but  was  con- 
trolled by  the  Prussian  Government.  The  Imperial 
Government  purchased  the  Prussian  interest,  raised  the 
capital  from  20,000,000  thalers  to  120,000,000  marks, 
and  sold  the  stock  to  private  interests. 

500.  Influence  of  government. — Although  the  gov- 
ernment is  not  a  stockholder  it  exercises  direct  control 
over  the  bank's  affairs,  so  that  it  is  much  more  essen- 
tially a  government  institution  than  are  the  banks  of 
England  and  France.     The  Chancellor  of  the  Empire 
is  the  governing  officer.     Associated  with  him  are  four 
directors,  one  named  by  the  Emperor,  and  the  others 
by  the  Federal  Council.     The  stockholders  elect  annu- 
ally a  commission  of  fifteen  members  which  acts  in  an 


EUROPEAN  BANKING  SYSTEMS  401 

advisory  capacity  but  has  no  real  control  of  the  bank's 
affairs. 

The  bank  acts  as  fiscal  agent  for  the  government 
without  pay;  and  furthermore,  the  stockholders  share 
the  profits  with  the  government.  First,  a  dividend  of 
3%  per  cent  is  paid  to  the  stockholders;  second,  one- 
fifth  of  the  balance  goes  into  the  bank's  surplus;  third, 
the  stockholders  and  the  government  then  share  equally 
until  the  stockholders  have  received  8  per  cent,  after 
which  the  government  receives  the  remainder. 

501.  Modeled  on  Bank  of  England. — The  regula- 
tions in  regard  to  the  issue  of  notes  were  modeled  upon 
the  laws  of  England  with  certain  modifications  which 
have  been  very  useful.     The  Reichsbank  was  given  a 
circulation  of  250,000,000  marks,  with  the  further  pro- 
vision that  when  other  note-issuing  banks    (of  which 
there  were  then  thirty-two)  gave  up  the  privilege,  the 
Reichsbank  might  increase  its  issue  in  like  amount.     At 
present  only  six  banks  still  issue  notes,  so  that  the  circu- 
lation of  the  Reichsbank  has  been  considerably  increased. 
Its  capital  was  increased  in  1905  to  180,000,000  marks, 
and  it  now  has  320  branches. 

502.  Reserves. — The  Reichsbank  is  required  to  keep 
a  cash  reserve  of  one-third  of  its  circulation,  two-thirds 
being  secured  by  first-class  commercial  paper  maturing 
within  ninety  days.     It  is  evident  that  this  provision 
renders  the  currency  much  more  elastic  than  that  of 
England  where  the  cash  reserve  must  be  100  per  cent. 
Furthermore,  the  Reichsbank  is  entitled  to  exceed  the 
limit  set  for  the  amount  of  notes  it  can  issue  by  paying 
a  tax  of  5  per  cent  per  annum  upon  all  circulation 
above  the  maximum  limit.     This  creates  a  circulation 
that  can  be  used  in  emergencies  without  the  necessity 
of  suspending  the  limit  by  special  enactment,  as  Eng- 


408  MONEY  AND  BANKING 

land  is  compelled  to  do.  This  plan  has  been  incor- 
porated into  a  number  of  the  systems  which  have  been 
suggested  for  adoption  in  the  United  States. 

It  is  worthy  of  note  that  no  special  fund  is  set  aside 
for  bank  note  redemption.  In  case  of  dissolution  the 
depositors  and  note  holders  would  be  in  the  same  posi- 
tion. The  deposit  currency,  however,  has  not  grown 
greatly  in  Germany,  so  that  the  note  holders  would 
always  be  the  chief  creditors.  The  system  has  worked 
out  very  well  in  practice.  The  notes  have  always  cir- 
culated freely  and  without  discount.  The  bank  has 
followed  the  precedent  of  the  Bank  of  England  and 
the  Bank  of  France,  and  conducts  its  affairs  on  a  very 
conservative  basis,  maintaining,  like  the  Bank  of 
France,  an  average  reserve  of  60  per  cent  of  its  circu- 
lation. In  its  conservatism  it  is  very  like  both  its  pred- 
ecessors ;  in  its  plan  of  note  issue  it  seems  to  have  taken 
a  middle  ground  between  the  two  older  schools,  adopt- 
ing many  of  the  good  points  of  each ;  but  in  its  manage- 
ment it  has  departed  entirely  from  the  other  institutions 
in  that  its  control  is  entirely  in  the  hands  of  the  Imperial 
Government. 


CHAPTER  XXX 

CANADIAN  BANKING  SYSTEM 

503.  The  bank  and  the  government. — The  banking 
system  of  the  Dominion  of  Canada  is  so  often  held  up 
by  the  advocates  of  asset  currency  and  branch  banking 
as  a  model  for  the  United  States  to  follow  that  it  is  well 
to  understand  thoroughly  the  details  of  the  system.     It 
is  likely  that  banking  features  which  prove  excellent 
in  Canada  may  not  be  adapted  to  conditions  in  this 
country. 

The  Canadian  system  is  composed  of  thirty-four 
large  joint  stock  commercial  and  industrial  banks,  pri- 
vately owned  and  managed  but  working  under  a  uni- 
form law  and  subject  to  the  supervision  of  the  Dominion 
Government.  No  bank  is  chartered  by  the  government 
with  a  capital  of  less  than  $500,000.  This  renders  it 
impossible  for  new  banks,  unless  they  are  sure  of  a  very 
great  volume  of  business  from  the  start,  to  be  estab- 
lished. The  thirty-four  central  banks  have  many 
branches,  690  in  all,  scattered  over  the  Dominion. 
'Banking  is  extended,  not  by  the  establishment  of  new 
banks  but  by  increasing  the  branches,  together  with  the 
capital  resources  of  the  existing  banks.  The  Canadian 
Banking  Act  is  revised  every  ten  years,  at  which  time 
all  the  bank  charters  are  renewed. 

504.  Security  of  note  issues. — The  banks  have  the  ex- 
clusive privilege  of  issuing  bank  notes  of  the  denomina- 
tion of  $5  and  multiples  thereof.     These  are  not  legal 

409 


410  MONEY  AND  BANKING 

tender.  The  small  paper  money  is  provided  by  the 
government.  The  bank  notes  are  secured,  first,  by  the 
double  liability  of  the  shareholders;  second,  by  a  first 
lien  of  the  note  holders  upon  the  assets  of  the  bank; 
third,  by  the  bank  circulation  redemption  fund ;  fourth, 
by  6  per  cent  interest  accruing  upon  the  notes  of  failed 
banks  from  the  date  of  refusal  to  redeem  to  the  date 
when  readiness  to  redeem  is  announced. 

The  banks  may  issue  notes  without  the  deposit  of 
bonds  or  without  any  restriction  except  those  already 
mentioned.  The  amount  is  limited  by  the  capital  of 
the  bank.  The  double  liability  of  the  shareholders  and 
the  first  lien  of  the  note  holders  upon  the  assets  of  the 
failed  bank  are  similar  to  our  own  national  bank  act. 

505.  Redemption  fund. — The  bank  circulation  re- 
demption fund  is  held  by  the  Minister  of  Finance  and 
draws  3  per  cent  interest.  It  is  maintained  out  of  con- 
tributions by  the  banks  and  must  always  equal  5  per  cent 
of  their  average  annual  circulation.  It  is  especially  set 
apart  for  the  payment  of  notes  of  failed  banks.  No 
payments  have  been  made  from  the  fund  since  1891. 
If  the  fund  becomes  impaired  the  banks  may  be  called 
upon  to  contribute  not  to  exceed  1  per  cent  of  their  cir- 
culation of  the  preceding  year. 

Notwithstanding  their  preference  as  to  assets,  before 
1890  the  notes  of  failed  banks  sometimes  sank  to  less 
than  fifty  cents  on  the  dollar  before  they  were  ultimately 
redeemed  at  par.  The  provision  by  which  they  yield 
6  per  cent  interest  holds  them  at  par  pending  their 
redemption,  for  the  reason  that  they  become  a  very 
desirable  investment  for  the  other  banks. 

Regarding  redemption  the  law  requires:  "The 
banks  shall  make  such  arrangements  as  are  necessary 
to  insure  the  circulation  at  par  in  any  and  every  part  of 


CANADIAN  BANKING  SYSTEM  411 

Canada,  of  all  the  notes  issued  or  reissued  by  them  and 
intended  for  circulation;  and  towards  this  purpose  the 
bank  shall  establish  agencies  for  the  redemption  and 
payment  of  its  notes  at  the  cities  of  Halifax,  St.  John, 
Charlottestown,  Montreal,  Winnipeg,  and  Victoria,  and 
at  such  other  places  as  are  from  time  to  time  designated 
by  the  Treasury  Board." 

Each  bank  is  anxious  to  keep  out  as  many  of  its  own 
notes  as  possible;  hence  it  pays  out  only  its  own  notes 
and  sends  in  for  redemption  the  notes  of  other  banks  as 
fast  as  they  are  received  by  it.  Bank  notes  are  redeemed 
in  exactly  the  same  way  as  checks  are  collected.  Wher- 
ever there  are  clearing  houses  the  notes  appear  in  the 
collections  the  same  as  checks.  Sometimes  in  the  height 
of  the  crop-moving  season  some  of  the  banks  reach  the 
limit  of  their  own  power  of  issue  and  may  then  pay  out 
the  notes  of  competitors,  but  as  soon  as  the  strain  relaxes 
the  safeguard  resumes  its  normal  function  of  limiting 
the  volume  of  circulating  medium  to  the  actual  needs 
of  business  at  the  moment. 

506.  System  very  elastic. — The  greatest  virtue  of  the 
Canadian  bank  note  currency  is  elasticity.     It  adapts 
itself  very  easily  to  the  needs  of  business.     The  effect 
of  this  is  to  keep  interest  rates  from  fluctuating  so 
widely,  as  with  us,  and  to  relieve  the  business  men  of 
the  apprehension  that  periods  of  stringency  may  come 
when  they  will  be  unable  to  borrow  money  at  all,  a  con- 
dition which  frequently  occurs  in  the  United  States. 
Inelasticity  is  the  distinguishing  feature  of  our  currency 
system,  and  the  great  obstacle  to  any  change  is  the  fear 
that  the  notes  will  become  less  secure. 

507.  Reserves. — The  Canadian  law  makes  no  require- 
ments of  the  banks  for  the  keeping  of  a  minimum  re- 
serve.    The  question  is  one  which  has  excited  wide 


412  MONEY  AND  BANKING 

discussion  in  Canada  but  the  weight  of  argument  seems 
to  be  on  the  side  of  those  who  think  that  a  reserve  re- 
quirement does  more  injury  than  benefit  to  the  com- 
munity. Our  reserve  requirements  have  been  compared 
by  a  Chicago  banker  to  certain  beds  in  a  hospital  kept 
for  emergencies;  on  the  occasion  of  a  great  disaster 
in  the  vicinity  of  the  hospital  the  superintendent  refused 
to  permit  the  beds  to  be  used,  saying  that  they  were  to 
be  reserved  for  emergencies.  The  necessity  of  main- 
taining the  legal  reserve  renders  our  banks  helpless  at  a 
time  when  they  should  be  loaning  freely  in  order  to  allay 
the  incipient  panic.  A  reserve  which  cannot  be  used 
is  of  no  avail  in  emergencies.  Business  prudence  has 
in  fact  led  the  Canadian  banks  to  maintain  reserves  which 
have  always  been  adequate,  and  they  have  even  been 
able  to  loan  funds  in  the  United  States  when  the  banks 
of  this  country  were  unable  to  extend  sufficient  accom- 
modation. 

508.  Branch  banking. — The  advantages  of  branch 
banking  are: 

1.  Large  capital  behind  each  institution.     No  matter 
how  small  the  branch  the  customers  share  in  the  security 
which  a  large  capital  offers. 

2.  Unity  of  policy  on  the  part  of  the  leading  banks 
during  a  stringency,  in  contrast  to  the  playing  at  cross 
purposes  which,  in  the  panic  of  1893,  distinguished  the 
action  of  the  national  banks  in  the  central  reserve  cities 
of  the  United  States  against  the  smaller  country  banks. 
In  1907,  if  the  country  banks  had  been  branches  of  the 
large  city  banks,  they  would  not  have  withdrawn  funds 
from  those  banks  when  they  were  so  badly  needed,  and 
the  crisis  would  not  have  been  so  severe. 

3.  Power  to  equip  every  branch  with  ample  reserves 
(for  maintaining  commercial  credit  bjr  means  of  note 


CANADIAN  BANKING  SYSTEM  413 

issues.  It  is  impossible  in  Canada  for  the  business  needs 
of  any  community,  no  matter  how  remote,  to  outstrip 
the  banking  facilities,  as  is  often  the  case  with  us.  The 
resources  of  the  branch  bank  are  quickly  and  indefi- 
nitely extended.  Moreover,  when  the  need  for  additional 
facilities  has  passed  the  business  of  the  bank  can  con- 
tract accordingly  without  loss  to  any  one. 

4.  Uniformity  of  interest  rates  throughout  the  whole 
country  which  do  not  vary  more  than  1  or  2  per  cent 
between  the  large  city  banks  and  the  frontier  points. 
In  the  absence  of  competition  the  necessity  of  depend- 
ing upon  small  local  banks  for  accommodation  requires 
the  business  men  of  western  towns  in  the  United  States 
to  pay  monopoly  rates  for  the  use  of  capital. 

5.  Expert  supervision  by  the  central  office  prevents 
bad  banking.     The  board  of  directors  of  the  large  banks 
are  responsible  as  well  for  all  the  branches  and  they  are 
therefore  forced  to  put  into  practice  a  method  of  exam- 
ination and  supervision  which  is  much  more  effective 
than  our  government  examination. 

6.  Branches  can  be  maintained  in  localities  where  the 
profit  of  the  business  would  not  justify  the  establish- 
ment of  a  separate  bank  with  independent  capital.     The 
city  banks  can  establish  branches  without  any  invest- 
ment in  additional  capital.     Branches  can  be  established 
where  the  business  is  so  small  as  to  justify  simply  the 
employment  of  one  clerk  in  a  rented  office. 

509.  Canadian  system  in  actual  operation. — We  turn 
now  to  the  manner  in  which  all  this  machinery  is  applied 
to  moving  the  crops.1 

"The  greatest  grain-producing  district  of  Canada  is 
the  far  inland  section  which  forms  the  Provinces  of 
Manitoba,  Saskatchewan,  and  Alberta.  The  larger  part 

i  Banker's  Magazine,  June,  1906, 


414  MONEY  AND  BANKING 

of  the  Canadian  crop  finds  a  market  abroad  and  has 
to  be  transported  to  the  Atlantic  seaboard.  In  the  case 
of  grain  grown  in  Ontario  or  the  eastern  provinces  this 
is  not  a  difficult  matter,  for  the  distance  is  shorter  and 
the  means  of  communication  numerous.  But  between 
the  provinces  we  have  mentioned  and  the  seaboard  the 
only  links  of  communication  are  one  or  two  vast 
stretches  of  single  track  railroad  supplemented  by  water 
communication  from  the  head  of  the  Great  Lakes.  But 
navigation  usually  closes  in  these  northern  waters  dur- 
ing November,  and  the  period  between  the  harvesting 
of  the  crop  and  the  close  of  navigation,  after  allowance 
is  made  for  the  time  consumed  in  threshing  and  market- 
ing the  grain,  is  all  too  short.  Hence  the  rush  to  ship 
which  takes  place  in  the  fall  of  each  year,  and  hence, 
too,  the  immense  storage  elevators  which  have  sprung 
up  at  the  lake  ports  of  Port  Arthur  and  Fort  William 
at  the  head  of  navigation.  Once  these  water  outlets 
are  closed  there  is  nothing  left  but  the  long  and  expen- 
sive railroad  haul. 

510.  Moving  the  crops. — "Long  before  the  movement 
of  the  crops  is  due  the  banks  make  arrangements  to  ac- 
cumulate large  supplies  of  notes  at  convenient  points, 
Winnipeg  being  naturally  the  chief  center  for  this  pur- 
pose. It  is  at  Winnipeg  that  the  large  milling  and 
elevator  companies  which  handle  most  of  the  grain  crops 
have  their  headquarters,  and  it  is  the  Winnipeg  branches 
of  the  banks  which  are  most  conveniently  situated  to 
replenish  the  tills  of  the  country  branches  and  to  pro- 
vide funds  for  the  country  storekeepers  who  cash  the 
grain  tickets  issued  by  the  wheat  buyers.  Scattered 
along  the  railroad  lines  in  the  west  at  the  little  way-sta- 
tions are  the  tall  buildings  of  the  grain  elevators,  and 
here  are  to  be  found  the  buyers  for  the  Winnipeg  grain 


CANADIAN  BANKING  SYSTEM  415 

firms.  To  these  the  farmer  brings  his  wheat,  receives 
a  voucher  called  a  grain  ticket  specifying  the  weight  of 
the  grain  he  has  sold  and  the  price  to  be  paid  for  it. 
These  tickets  are  cashed  at  the  local  banks  or,  if  there 
is  no  bank,  by  the  country  storekeepers,  arrangements 
for  supplying  the  latter  with  notes  for  this  purpose 
having  been  made  by  the  companies  in  Winnipeg. 
Checks  are  seldom  used  in  transactions  of  this  kind  with 
the  farming  community.  At  this  season  of  the  year 
the  business  of  a  country  branch  bank  even  in  very  small 
places  will  be  very  active,  and  large  sums  are  daily  paid 
out  over  the  counters. 

511.  Grain  as  security. — "The  Canadian  banks  are 
specially  empowered  under  the  bank  act  to  acquire  ware- 
house receipts  and  bills  of  lading  as  collateral  security 
and  to  lend  money  to  wholesale  shippers  of  or  purchasers 
of  or  dealers  in  agricultural  products  upon  the  security 
of  such  products.  So  the  banks  readily  make  advances 
to  the  grain  dealers  on  the  security  of  the  grain  in  their 
possession.  Then  when  it  is  shipped  by  the  wholesale 
dealer  the  advances  are  retired  by  drafts  on  the  pur- 
chasers with  bills  of  lading  attached.  If  the  grain  is 
to  be  exported  the  bill  of  lading  is  usually  replaced  at 
the  port  of  shipment  by  an  ocean  bill  of  lading,  which 
is  in  its  turn  attached  to  a  bill  of  exchange  on  the  foreign 
dealer.  This  exchange  is  then  purchased  by  the  bank, 
the  previous  drafts  having  been  retired,  and  forwarded 
to  its  correspondents  abroad.  The  bank  finally  receives 
credit  for  the  proceeds  in  London  or  some  other  Euro- 
pean center. 

"By  this  time  the  bank  notes  originally  issued  for  the 
purchase  of  grain  have  come  in  for  redemption,  and  the 
issuing  bank,  to  obtain  funds  to  meet  its  clearing-house 
settlements,  will  be  forced  to  sell  sterling  or  New  York 


416  MONEY  AND  BANKING 

funds  or  else  to  import  gold.  As  the  balance  of  trade 
between  Canada  and  the  United  States,  most  of  which 
is  finally  discharged  in  New  York,  is  against  Canada, 
there  is  a  fairly  steady  demand  for  New  York  funds  in 
the  financial  centers,  and  there  will  usually  be  found 
some  bank  willing  to  buy.  But  as  the  proceeds  of  the 
grain  shipments  are  still  in  Europe,  the  selling  bank  will 
provide  cover  for  its  drawings  on  New  York  by  selling 
sterling  or  other  foreign  exchange  on  that  market 
against  the  credit  balances  acquired  abroad  by  means 
of  the  bills  of  exchange  drawn  against  the  shipments 
of  the  very  grain  for  the  purchase  of  which  in  the  first 
place  its  notes  were  issued.  If  gold  is  imported  the 
resulting  transactions  are  very  similar,  as  New  York 
is  the  point  from  which  it  is  usually  obtained.  In  this 
connection  it  is  interesting  to  note  that  some  of  the 
Canadian  banks  are  among  the  largest  dealers  in  for- 
eign exchange  in  New  York,  where  the  credit  of  their 
bills  is  unexcelled.  So  extensive  are  these  foreign  trans- 
actions that  several  of  the  Canadian  banks  maintain 
their  own  offices  in  New  York,  and  even  in  London,  for 
the  purpose  of  looking  after  their  own  interests  at  these 
points." 

512.  Fluctuations  in  note  circulation. — We  have 
now  traced  the  series  of  transactions  involved  in  the 
issue  of  bank  notes  for  the  purchase  of  grain  up  to  the 
redemption  of  these  notes  in  Canada  and  the  final  liqui- 
dation of  the  whole  matter  in  New  York  and  London. 
Bearing  in  mind  what  has  been  said  as  to  the  shortness 
of  the  season  for  marketing  the  grain  of  the  vast  fields 
of  the  West,  it  will  be  readily  understood  that  tremen- 
dous fluctuations  in  the  volume  of  the  bank  note  cur- 
rency take  place  in  the  course  of  a  short  period.  The 
redemption  of  the  notes  issued  to  pay  for  the  crops  is 


CANADIAN  BANKING  SYSTEM  417 

completed  in  January  of  each  year,  and  this  month 
marks  the  lowest  level  of  the  year.  There  is  a  second 
slight  dip  during  the  spring  and  a  third  culminating 
about  midsummer. 

For  thirty  years  prior  to  1896  the  lowest  point  of 
the  year  had  been  reached  regularly  in  May  or  June, 
but  since  that  date  it  has  with  equal  regularity  been 
transferred  to  January.  In  1905,  however,  the  differ- 
ence in  level  between  January  and  May  was  very  slight, 
the  note  circulation  dropping  to  $58,021,000  in  Jan- 
uary and  to  $58,136,000  in  May. 

January  is  a  month  usually  marked  by  a  lull  in  bus- 
iness. The  holiday  trade  is  over,  winter  has  set  in 
steadily,  and  some  outdoor  occupations  are  suspended 
for  a  time,  while  the  majority  of  business  men,  in  both 
wholesale  and  retail  trade,  are  taking  stock.  As  winter 
wears  on  business  becomes  much  more  active  and  the 
note  circulation  rises  for  a  time,  to  experience  a  slight 
fall  in  the  early  spring  when  many  factories  shut  down 
for  repairs,  lumber  camps  close  and  the  men  are  dis- 
charged, and  other  winter  employments  come  to  an  end. 
It  resumes  the  upward  course  as  summer  occupations  be- 
gin again,  navigation  on  the  Great  Lakes  reopens,  and 
general  business  gets  into  full  swing.  Midsummer 
brings  a  slight  falling  off,  as  might  be  expected,  but  soon 
the  heavier  movement  of  farm  produce  begins  and  the 
note  circulation  at  once  responds.  The  rise  is  some- 
what gradual  at  first,  but  as  cattle  buyers,  owners  of 
cheese  factories,  and  finally  grain  buyers  look  to  the 
banks  for  notes  with  which  to  pay  the  farmers,  it  in- 
creases in  velocity.  Now  the  volume  of  the  circulation 
begins  to  mount  by  leaps  and  bounds,  reaching  its 
height  at  the  end  of  October  or  the  beginning 
of  November  when  every  nerve  is  being  strained  to 

VII— 27 


418  MONEY  AND  BANKING 

hurry  as  much  as  possible  of  the  western  crops  to  market 
and  to  the  seaboard  before  navigation  closes  on  the  inland 
waterways.  The  period  of  rapid  expansion  covers  the 
three  months  August,  September,  and  October,  and 
probably  part  of  November  as  the  exact  figures  are 
only  available  at  the  end  of  each  month.  During  this 
period  the  increase  in  volume  has  ranged  of  late  years 
from  20  per  cent  to  35  per  cent,  according  to  the  size 
of  the  crop  to  be  marketed.  A  period  of  contraction, 
even  a  little  more  rapid  than  the  expansion,  now  follows 
and  lasts  till  the  end  of  January,  when  the  lowest  level 
of  the  next  year  is  reached. 


CHAPTER  XXXI 

SUMMARY  OF  CURRENCY  AND  BANKING  PRINCIPLES 

513.  Elasticity. — The  following  principles  should  be 
observed  in  making  any  change  in  our  currency  and 
banking  system.  They  are  deductions  drawn  from  the 
history  of  banking  both  of  this  country  and  abroad,  from 
a  comparative  study  of  the  systems  of  the  leading  civ- 
ilized countries,  and  from  a  general  study  of  economic 
theory. 

The  currency  of  a  country  should  always  be  so 
adjusted  to  the  demand  for  it  that  fluctuations  of 
prices  due  to  changing  quantities  of  currency  may  be 
reduced  to  the  minimum.  A  currency  which  is  too 
inelastic  to  respond  to  changes  in  demand,  especially 
seasonal  demands,  or  the  quantity  of  which  is  subject 
to  changes  independent  of  changes  in  demand,  is  de- 
fective. 

2.  A  currency  which  in  any  way  increases  the  amount 
of  speculation  is  defective. 

Our  currency  is  elastic  but  its  elasticity  is  not  respon- 
sive to  the  demands  of  business.  Gold  is  the  only  ele- 
ment which  expands  and  contracts  rationally.  Silver 
certificates  and  greenbacks  are  inelastic.  National  bank 
notes  expand  and  contract  with  the  price  of  bonds  and 
not  with  demand ;  they  change  too  slowly. 

The  deposit  currency  is  elastic,  but  is  subject  to  sudden 
and  enormous  fluctuations  in  amount  which  have  a  pro- 
found effect  on  prices  and  business.  This  is  due  to 
defects  in  the  cash  currency,  to  reserve  laws,  to  our  sub- 

419 


420  MONEY  AND  BANKING 

treasury  system,  and  to  the  danger  of  "runs"  on  banks. 
Any  reform  in  banking  and  currency  should  tend  to 
bring  the  deposit  currency  into  conformity  with  Prin- 
ciples 1  and  2. 

514.  United    States    currency. — 3.  Any    currency 
which  encourages  the  perpetuation  of  the  national  debt 
or  of  state  or  municipal  debts  is  defective.    Governments 
should  be  as  free  from  debt  as  possible  so  that  they 
may  be  strong  in  emergencies.     Bank  currency  should 
be  as  independent  of  the  fortunes  of  the  government 
as  possible,  so  as  to  be  a  support  rather  than  a  burden 
in  time  of  stress. 

This  principle  is  violated  in  the  National  Bank  Act 
and  in  the  Aldrich  bill.  They  both  give  artificial  values 
to  bonds  and  create  vested  rights  which  make  it  difficult 
to  change  the  system. 

4.  The  government  is  not  a  proper  agent  to  issue 
and  keep  outstanding  demand  obligations  which  circu- 
late as  money.  Such  obligations  embarrass  the  govern- 
ment in  emergencies,  impair  its  credit  at  the  most 
inopportune  time,  and  interfere  with  the  financial  opera- 
tions of  the  government. 

515.  Sub-treasury  system. — 5.  The  fiscal  operations 
of  the  government  should  interfere  as  little  as  possible 
with  the  quantity  of  currency  in  circulation.     The  sub- 
treasury  system  withdraws  from  circulation  large  sums 
which  must  be  restored  by  the  Secretary  of  the  Treasury 
as  government  deposits.     Too  much  responsibility  is 
placed  on  this  official,  and  banks  are  likely  to  be  drawn 
into  politics.     A  central  bank  acting  as  fiscal  agent  of 
the  government  would  obviate  this  defect.     The  Fowler 
bill  would  force  the  banks  to  pay  interest  on  these  de- 
posits and  eliminate  the  bond-deposit  requirement,  thus 


securing  an  automatic  and  natural  distribution  of  the 
government  deposits. 

516.  Reserves. — 6.  Credit  should  not  be  permitted 
to  expand  out  of  proportion  to  reserves  held  for  liquida- 
tion. Reserves  should  be  available  for  liquidation 
wherever  the  demand  appears.  Prompt  liquidation 
may  stop  an  incipient  panic.  Reserve  requirements 
should  be  flexible  enough  to  meet  emergencies  but  not 
so  flexible  as  to  encourage  speculation. 

7.  Credit  in  any  form  should  never  be  used  as  re- 
serve, since  a  weakness  in  the  foundation  may  cause  a 
collapse  of  the  superstructure.     The  Fowler  bill  pro- 
viding that  reserves  shall  be  kept  in  gold  is  sound.     A 
grave  defect  in  our  system  is  the  state  banks  and  trust 
companies  with  too  small  reserves  or  reserves  in  the  form 
of  national  bank  credit. 

8.  All  forms  of  demand  credit,  bank  notes,  or  deposit 
currency  should  be  protected  by  reserves. 

9.  The  best  banking  system  is  one  in  which  the  cash 
reserve  is  most  effective  in  performing  its  function. 
A  small  reserve  capable  of  quick  mobilization  at  the 
place  where  demand  for  liquidation  in  cash  threatens 
is  more  effective  than  a  large  one  which  is  immobile  or 
which  is  segregated  in  times  of  panic.     A  centralized 
banking  system  increases  the  effectiveness  of  the  re- 
serve.    In  this  respect  the  English  and  Canadian  sys- 
tems are  far  superior  to  the  American.     Our  reserves 
are  drawn  into  the  money  centers  to  increase  speculation 
and  leave  when  the  need  for  them  arises. 

10.  A  stringency  arising  because  expansion  of  credit 
has  reached  its  limit  in  relation  to  the  existing  reserve 
is  wholesome  and  natural,  but  it  is  a  critical  moment  in 
finance.     The  reserves  must  be  maintained  to  avoid  a 


MONEY  AND  BANKING 

sudden  contraction  of  credit  followed  by  wholesale  liqui- 
dation and  panic. 

12.  Cash  should  leave  the  banks  only  in  response  to  a 
legitimate  demand  for  it.  The  only  legitimate  demand 
is  for  circulation  or  settlement  of  foreign  balances. 
Hoarding  by  individuals,  the  government,  or  country 
banks  is  preventable. 

517.  Guarantee  of  deposits. — 13.  Guarantee  of  bank 
deposits  will  prevent  hoarding  by  individuals  and  banks. 
It  is  advocated,  not  to  protect  depositors,  but  to  protect 
reserves  and  prevent  sudden  and  unnecessary  contrac- 
tion. 

14.  Guarantee  of  bank  deposits  must  not  encourage 
unsound  and  speculative  banking.     It  must  not  protect 
an  insolvent  bank  from  failure  and  permit  it  to  continue 
its  career,  growing  more  and  more  involved  all  the 
time.     There  must  be  some  power  to  close  an  insolvent 
bank  before  the  shrinkage  of  assets  exhausts  the  surplus 
and  capital. 

15.  The  loss  from  bank  failures  should  fall  on  the 
men  responsible  for  them  as  far  as  possible.     Hence 
the  directors  should  bear  the  loss  whenever  such  loss 
has  been  incurred  either  through  their  negligence  or 
culpability. 

16.  Whenever  the  banks  are  required  to  contribute 
to  a  fund  to  pay  the  losses  of  depositors  in  a  bank  fail- 
ure, they  should  be  given  power  to  prevent  such  failure. 
Banks  should  be  mutually  responsible  only  in  a  small 
district.     It  would  be  absurd  to  make  the  banks  of 
Maine  liable  for  bad  banking  in  California.     The  banks 
of  Illinois,  however,  might  very  properly  be  responsible 
for  each  other  if  they  were  empowered  to  check  bad 
banking  among  themselves;  then  failure  and  loss  could 


CURRENCY  AND  BANKING  PRINCIPLES       423 

occur  only  through  negligence  on  their  part  and  they 
themselves  would  be  to  blame. 

17.  Depositors  of  a  failed  bank  should  be  paid  at  once 
from  a  fund.     The  most  serious  results  from  failure 
of  banks  is  the  delay  in  payment  rather  than  in  final 
loss;  both  are  absolutely  unnecessary  and  the  fear  that 
such  delay  and  loss  might  occur  cost  the  country  hun- 
dreds of  millions  of  dollars  in  1907.     No  form  of  emer- 
gency currency  would  have  prevented  this. 

18.  Where  the  law  has  been  violated  or  where  failures 
have  been  caused  by  loans  to  directors  or  to  corporations 
or  firms  in  which  they  have  been  interested,  the  direc- 
tors should  be  personally  liable,  because  they  are  respon- 
sible and  can  easily  avoid  liability.     The  shareholders 
can  be  prevented  from  electing  irresponsible  directors 
by  making  them  liable,  above  their  double  liability  al- 
ready existing,  for  any  deficit  after  the  directors'  lia- 
bility has  been  exhausted. 

19.  Practically  no  bank  failures  have  caused  any  loss 
to  depositors  in  which  the  directors  have  not  permitted, 
negligently  or  culpably,  the  violation  of  law  or  a  gross 
violation  of  their  trust  in  loaning  the  funds  of  the  bank 
to  themselves. 

518.  State  banks  and  trust  companies. — 20.  A  great 
obstacle  to  a  thorough  reform  of  the  currency  is  the 
existence  of  the  state  banks  and  trust  companies,  which 
are  exempt  from  all  regulation  by  the  National  Bank 
Act.  Though  deprived  of  the  right  to  issue  bank  notes, 
these  banks  have  a  power  (unlimited  in  some  states)  to 
increase  the  deposit  currency  at  will.  They  may  count 
national  bank  notes  as  part  of  their  reserve,  thus  making 
a  true  asset  currency  impossible  or  dangerous.  Trust 
companies,  especially,  compete  unfairly  with  national 


424  MONEY  AND  BANKING 

banks  and  then  expect  the  latter  to  support  them  in 
times  of  emergency.  National  banks  should  be  per- 
mitted to  have  savings  and  trust  departments  subject 
to  laws  as  thorough  as  the  Massachusetts  or  New  York 
laws.  Any  measure  such  as  the  guarantee  of  deposits 
or  other  privileges  would  tend  to  induce  state  institu- 
tions to  change  to  national,  and  this  is  desirable.  The 
decentralized  national  banking  system  is  bad  enough 
but  when  to  that  is  added  the  state  systems,  entirely  dis- 
connected from  and  competing  with  the  national  sys- 
tem, the  prospect  of  harmonious  action  of  all  banks 
for  their  common  good  is  small. 

519.  Unity  of  action. — 21.  Any  tendency  toward 
unity  of  action  on  the  part  of  the  banks  is  good.  A 
central  bank,  strong  enough  to  control  the  situation  at 
all  times  and  patriotic  enough  to  sacrifice  present  profit 
for  the  general  benefit  of  the  whole  business  community, 
is  the  ideal  plan.  Any  plan  for  unifying  the  banks 
into  clearing  house  associations  is  a  step  in  this  direc- 
tion. 

22.  A  clearing  house  for  clearing  country  checks 
would  effect  an  enormous  economy  in  collections  and 
would  assist  in  unifying  the  banks. 

23.  Branch  banking  is  desirable  because  it  economizes 
reserves  and  capital,  affords  banking  facilities  to  com- 
munities now  unable  to  support  a  bank,  and  would  ena- 
ble the  borrower,  say  in  Texas,  to  get  a  loan  at  as  low 
a  rate  (security  being  the  same)  as  the  business  man,  say 
in  Chicago,  the  benefit  of  which  would  shift  to  the  seller 
of  cotton  and  other  products  and  the  consumer  of 
goods. 

24.  It  is  possible  to  prevent  a  centralized  banking 
system  from  being  exploited  by  speculative  interests 
jthrough  restrictions  as  to  stockholders,  directors  and 


CURRENCY  AND  BANKING  PRINCIPLES      425 

officers.  "Put  your  eggs  in  one  basket  and  then  watch 
the  basket." 

25.  There  should  be  an  institution  strong  enough  in 
credit  and  resources  to  be  ready  at  all  times  to  re-dis- 
count good  commercial  paper.  The  United  States  will 
never  be  a  great  international  money  market  until  good 
paper  can  be  discounted  at  any  time  at  less  than  8  per 
cent.  Many  really  solvent  banks  have  failed  because 
they  were  unable  to  convert  their  assets  into  cash  at  any 
rate.  Such  failures  are  absolutely  unnecessary  and  in- 
troduce a  needless  risk  into  the  banking  business. 

520.  Speculation. — 26.  Exchange  is  of  two  sorts: 
necessary  trading  and  speculation.  Necessary  trading 
is  buying  and  selling  of  property  the  purpose  of  which 
is  to  increase  the  utility  of  the  property:  the  motive 
for  such  exchange  being  the  profit  arising  out  of  the 
increased  utility  of  the  property.  The  merchant  in- 
creases the  utility  of  goods  by  getting  them  one  step 
nearer  the  consumer  to  whom  they  have  the  highest 
utility.  The  broker  increases  the  utility  of  stocks  and 
Ixmds  by  passing  them  along  to  the  investor. 

Speculation  is  exchange,  the  purpose  of  which  is  a 
profit  arising  out  of  an  increase  in  value  not  due  to  an 
increase  in  utility  but  to  market  fluctuations.  Specula- 
tive exchanges  do  not  get  the  property  any  nearer  its 
final  destination  in  the  economic  process. 

Speculation  is  of  two  sorts:  Legitimate  and  illegit- 
imate. The  function  of  legitimate  speculation  is  to 
equalize  supply  and  adapt  it  to  demand,  thus  decreasing 
fluctuations  of  price  and  avoiding  sudden  changes. 
Such  trading  requires  full  knowledge  of  the  conditions 
of  supply  and  demand. 

Illegitimate  speculation  tends  to  increase  fluctuations 
of  price,  either  through  trading  in  ignorance  of  condi- 


426  MONEY  AND  BANKING 

tions  of  supply  and  demand  (gambling),  or  by  manip- 
ulating the  market  and  causing  temporary  changes  not 
justified  by  supply  and  demand. 

27.  Illegitimate  speculation  is  an  unmitigated  evil 
and  is  responsible  for  a  large  economic  loss  to  the  coun- 
try.    It  creates  panics  and  causes  unnecessary  indus- 
trial stagnation. 

28.  In  attempting  to  eradicate  illegitimate  specula- 
tion care  must  be  taken  to  avoid  hampering  necessary 
trading  and  legitimate  speculation. 

521.  Credit  necessary. — 29.  Credit  is  the  instrument 
of  speculation,  and  without  credit  no  general  specula- 
tive change  of  prices  could  take  place.  Currency  di- 
verted in  one  direction  to  increase  price  must  be  taken 
from  another  direction  causing  a  depression  there. 
Credit,  however,  affords  an  instrument  created  for  the 
purpose. 

30.  Credit  is  a  necessary  medium  of  exchange  under 
present  conditions,  and  if  we  restrict  its  use  we  run  the 
danger  of  hindering  legitimate  commerce.     The  prob- 
lem is:     How  to  provide  an  abundant  credit  currency 
for  commerce  which  the  speculators  cannot  divert  to 
their  own  uses? 

31.  The  plan  to  withhold  from  the  central  reserve  city 
banks  the  reserves  of  other  banks,  a  portion  of  which  is 
now  permitted  to  be  held  by  the  central  reserve  city 
banks,  would  curtail  the  credit  currency  of  those  banks 
and  would  hamper  commerce.     Speculators  are  always 
able  to  bid  higher  for  loanable  funds  when  they  want 
them,  so  the  contraction  would  harm  commerce  rather 
than  speculation. 

32.  A  plan  is  desired  by  which  commerce  might  have 
at  all  times  abundant  credit  currency  not  available  to  the 
speculators. 


CURRENCY  AND  BANKING  PRINCIPLES       427 

522.  Financial  and  commercial  banks. — 33.  Suppose 
we  separate  the  national  banks  in  the  central  reserve 
cities  into  two  classes:  Commercial  and  financial. 

Financial  banks  should  be  allowed  to  loan  on  collateral 
security  to  brokers  and  speculators  but  they  must  make 
public  every  transaction,  giving  the  name  of  the  bor- 
rower, the  name  of  the  collateral,  and  the  terms  of  the 
loan.  They  should  not  be  permitted  to  act  as  reserve 
agents  of  national  banks,  or  to  issue  bank  notes.  They 
should  have  trust  company  functions,  and  deal  in  bonds. 

34.  Commercial  banks  should  not  loan  on  collateral 
security,  unless  the  borrower  makes  affidavit  that  the 
proceeds   are   not   to   be   used   in   purchasing   stocks. 
Granting  of  loans,  the  proceeds  of  which  are  used  to 
trade  in  stocks  or  speculative  commodities,  should  cause 
the  bank  to  be  classed  as  a  financial  bank. 

Commercial  banks  should  be  allowed  to  act  as  reserve 
agents,  and  to  issue  bank  notes  based  on  assets.  They 
should  have  trust  and  savings  functions. 

35.  National  banks  should  not  be  permitted  to  keep 
deposits  in  state  banks  or  trust  companies  except  for 
the  purpose  of  necessary  exchanges.     This  would  limit 
the  power  of  state  banks  and  trust  companies  in  giving 
aid  to   speculation.     Legislatures,   especially    in   New 
York,  should  be  urged  to  limit  speculation  along  the 
same  lines. 

36.  Every  broker  should  be  registered  with  the  state 
officer  of  banking,  and  his  books  should  be  open  at  all 
times  to  the  inspection  of  proper  officials.     A  tax  on 
every  transaction  is  advisable  because  it  makes  specula- 
tion more  expensive  while  it  does  not  interfere  to  any 
great  extent  with  legitimate  trading. 

528.  Function  of  commercial  bank. — 37.  The  proper 
function  of  a  commercial  bank  is  to  provide  working 


428  MONEY  AND  BANKING 

capital  to  industry.  It  is  very  difficult  for  the  law  to 
distinguish  between  fixed  and  working  capital  loans. 
The  prohibition  of  loans  on  mortgage  security  is  an 
attempt  in  this  direction,  but  loans  on  personal  security 
may  be  used  for  investment  in  land,  and  loans  on  mort- 
gage bonds  are  not  prohibited  while  merchants  of  lim- 
ited credit,  unable  to  give  any  security  besides  land  for 
loans  for  strictly  industrial  uses,  are  refused  assistance. 

38.  Fixed  capital  is  capital  invested  in  real  estate, 
factory  buildings,  machinery,  fixtures,  etc. 

Working  capital  is  capital  invested  in  raw  materials, 
fuel,  wages,  and  other  running  expenses,  especially 
credit  given  to  customers.  The  amounts  invested  will 
be  realized  in  cash  by  the  borrower  within  six  months  in 
the  natural  course  of  the  economic  process. 

39.  The  reason  banks  should  loan  only  working  cap- 
ital is  not  that  such  loans  have  better  security  but  that 
the  cash  for  payment  at  maturity  of  the  note  appears 
automatically  through  the  "ripening"  and  sale  of  the 
products  of  the  business.     Everything  which  accelerates 
the  industrial  process  is  of  public  benefit. 

Investment  of  capital  in  fixed  forms  should  be  left 
to  investors  and  savings  banks.  Commercial  paper  and 
not  bonds  are  the  proper  assets  of  a  commercial  bank. 
Furnishing  funds  for  the  purchase  or  flotation  of  bond 
issues  is  not  a  proper  function  of  the  bank,  for  bonds 
do  not  liquidate  themselves  naturally.  The  more  bonds 
are  held  by  banks  the  more  difficult  will  it  be  to  realize 
cash  for  them  in  an  emergency  and  the  less  able  will  the 
banks  be  to  serve  the  legitimate  business  interests  of 
the  community. 

40.  The  provision  prohibiting  loans  on  real  estate  is 
a  clumsy  attempt  to  accomplish  a  certain  purpose.     Na- 
tional banks  should  be  permitted  to  have  bond  and  in- 
ivestment  departments. 


QUIZ  QUESTIONS 

( The  numbers  refer  to  the  numbered  sections  in  the 

text.) 

CHAPTER  I 

1.  Name  the  chief  reason  why  the  study  of  money 
and  banking  is  of  advantage  to  the  business  man.     Is 
it  fair  to  place  as  much  blame  upon  legislators  for  a 
bad  currency  system  as  upon  architects  for  a  bad  build- 
ing? 

2.  Were  warnings  given  of  the  panic  of  1907? 

3.  What  is  the  relation  between  the  sciences  of  money, 
finance  and  economics? 

4.  What  is  the  science  of  finance? 

5.  Show  how  every  business  has  a  technical  and  a 
business  side. 

6.  Why  is  business  the  result  of  the  specialization  of 
labor? 

7.  Name  the  phases  of  production. 

8.  How  is  the  changing  of  ownership  productive? 

9.  When  did  the  value  of  exchange  begin  to  be  recog- 
nized? 

10.  In  what  countries  are  the  rights  of  private  prop- 
erty most  strictly  enforced? 

11.  Distinguish  between  property  and  wealth.     Is 
money  wealth? 

12.  What  is  the  effect  of  the  integration  of  industry? 

429 


430  MONEY  AND  BANKING 

CHAPTER  II 

13.  Describe  three  stages  of  economic  history  based 
on  the  method  of  exchange. 

14.  What  are  the  obvious  limitations  of  exchange  by 
barter? 

15.  Show  how  the  introduction  of  a  medium  of  ex- 
change simplifies  trade.     Explain  why  "all  trade  is 
finally  barter." 

16.  Show    that    money    represents    incomplete    ex- 
changes.    How  does  the  miser  differ  from  other  people 
in  his  attitude  towards  money?     Show  the  similarity  be- 
tween money  and  a  railroad  ticket. 

17.  Define  credit.     What  other  meaning  of  the  word 
sometimes  leads  to  confusion? 

18.  Why  is  credit  a  good  medium  of  exchange?     Do 
you  think  that  merchants  and  bankers  earn  their  incomes 
as  truly  as  farmers  or  laborers? 

19.  Are  money  and  credit  real  wealth?    Would  you 
expect  a  millionaire  to  have  much  money  in  his  posses- 
sion? 

20.  Distinguish  between  production  and  consumption 
goods. 

21.  Describe  the  entrepreneur  system  of  production. 

22.  What  is  capital?     From  what  source  does  it  de- 
rive its  economic  importance? 

23.  Define  "capitalization."     How  is  it  possible  to 
know  when  a  corporation  is  over-capitalized? 

24.  From  whom  comes  the  demand  for  capital  goods 
and  for  what  purpose?     How  may  the  entrepreneur  ac- 
quire purchasing  power? 

25.  On  what  human  motives  does  the  accumulation  of 
capital  depend? 


QUIZ  QUESTIONS  431 

26.  Name  four  methods  by  which  the  saver  of  the 
income  may  invest. 

27.  Show  how  a  good  currency  system  increases  the 
incomes  of  all  producers. 

CHAPTER  III 

28.  Explain  how  value  is  a  register  of  economic 
forces.    Explain  the  meaning  of  the  phrase,  "profit  is 
the  mainspring  of  industry." 

29.  Give  a  definition  of  the  word  "value."     What  is 
meant  by  the  expression  "common  measure  of  value"? 

30.  Give  the  legal  definition  of  the  dollar. 

31.  What  is  the  sole  utility  of  money?    Why  is  it 
loanable? 

32.  What  objections  are  there  to  gold  as  a  standard 
of  value? 

33.  Show  why  the  cost  of  production  theory  of  value 
is  unsatisfactory. 

34.  State  briefly  the  utility  theory  of  value. 

35.  Define  "marginal  utility."     Show  how  it  is  illus- 
trated in  the  demand  for  automobiles. 

36.  What  is  the  "law  of  satiety"  ?    What  is  its  relation 
to  the  theory  of  marginal  utility? 

37.  How  may  the  two  theories  of  value  be  reconciled? 

CHAPTER  IV 

38.  Define  "exchange  utility." 

39.  What  commodities  were  first  used  as  standards  of 
value? 

40.  What  three  functions  of  money  were  developed 
in  primitive  money? 

41.  What  was  wampum?    What  gave  it  its  value? 


432  MONEY  AND  BANKING 

42.  Why  were  beaver  skins  used  as  money  by  the 
early  settlers  of  the  United  States? 

43.  What  were   the   disadvantages   of   agricultural 
products  as  money? 

44.  What  laws  were  passed  in  Virginia  to  maintain 
the  value  of  tobacco?    Did  they  succeed?     Compare  the 
destruction  of  growing  tobacco  plants  in  early  Virginia 
to  the  same  acts  committed  by  the  "night  riders"  in 
Kentucky  in  1906.     To  what  modern  form  of  currency 
in  the  United  States  may  the  "tobacco  notes"  be  com- 
pared? 

45.  Name  the  qualities  which  must  be  possessed  by  a 
good  currency. 

46.  Why  is  the  quality  of  divisibility  necessary? 

47.  Why  were  beaver  skins  unsuitable  for  use  as 
money  on  account  of  their  lack  of  uniformity? 

48.  Why  should  a  substance  used  as  money  possess 
the  quality  of  cognizability? 

49.  Why  have  civilized  countries  generally  adopted 
gold  and  silver  as  money?     Do  these  metals  possess 
stability  of  value? 

CHAPTER  V 

50.  Why  were  silver  and  gold  the  fittest  standards  to 
survive  ? 

51.  Name  the  good  qualities  of  silver  and  gold  as 
money. 

52.  When  and  where  was  platinum  used  as  money? 
Why  was  the  experiment  a  failure? 

53.  Name  the  defects  of  gold  and  silver  as  money. 

54.  How  have  two  of  the  defects  of  gold  and  silver 
been  overcome? 

55.  How  did  the  earlier  coins  get  their  names? 


QUIZ  QUESTIONS  433 

56.  Name    three    requirements    of    good    coinage. 
What  motives  led  to  the  debasement  of  the  coinage? 
Who  was  injured  by  the  debasement  of  the  coinage? 

57.  What  is  the  essential  quality  of  the  standard  of 
value? 

58.  Why  would  silver  disappear  from  circulation  if 
the  demand  for  its  use  in  manufactures  increased? 

59.  What  is  Gresham's  Law? 

60.  How  did  the  earlier  legislators  attempt  to  deal 
with  the  effects  of  Gresham's  Law?     What  result? 

61.  Give  a  brief  sketch  of  England's  experience  with 
the  double  standard. 

62.  How  did  England  come  to  adopt  the  single  gold 
standard? 

63.  What  effect  has   minting  upon   the   value   of 
metals? 

64.  Define  "legal  tender." 

65.  What    were    Alexander    Hamilton's    proposals 
respecting  coinage  in  the  United  States  in  1791? 

66.  Why  was  the  ratio  of  15:1  unsatisfactory? 

67.  Why  was  there  no  gold  coined  in  the  United 
States  before  1834? 

68.  Why  did  the  newly-coined  silver  dollars  disappear 
from  circulation? 

69.  What  change  did  Congress  make  in  the  ratio  in 
1834?    What  was  the  effect? 

70.  What  change  occurred  in  the  standard  in  1863? 

71.  How  was  the  single  gold  standard  adopted  in  the 
United  States? 

72.  For  what  did  the  Act  of  1900  provide? 

73.  Briefly  sum  up  the  evolution  of  the  standard  in 
the  United  States? 


VII— 28 


434  MONEY  AND  BANKING 

CHAPTER  VI 

74.  Show  why  gold  is  defective  as  a  standard  of  de- 
ferred payments. 

75.  Find   illustrations   to   prove   the   economic   ad- 
vantage of  the  enforcement  of  contracts. 

76.  How  may  contracts  be  impaired  by  legal  tender 
laws? 

77.  On  what  grounds  were  the  Legal  Tender  Acts 
declared  constitutional? 

78.  Why  were  the  defects  of  gold  as  a  standard  of 
deferred  payments  the  cause  of  the  free  silver  agitation 
in  1896? 

CHAPTER  VII 

79.  Distinguish  clearly  between  value  and  price  and 
show  that  the  prices  of  goods  depend  as  much  upon  the 
value  of  money  as  upon  the  value  of  the  goods. 

80.  How  is  it  possible  for  prices  to  rise  when  the  con- 
ditions of  supply  and  demand  seem  to  warrant  a  de- 
cline? 

81.  What  is  the  utility  of  money? 

82.  Distinguish  between  "desire5*  for  money  and  the 
economic  "demand"  for  it. 

88.  Name  and  define- three  varieties  of  money. 

84.  Give  illustrations  of  fiat  and  credit  money. 

85.  Analyze  the  demand  for  money. 

86.  What  determines  the  rapidity  of  circulation  of 
money? 

87.  What  effect  has  population  on  the  demand  for 
money? 

88.  What  is  the  relation  between  division  of  labor  and 
the  circulation  of  money?    What  effect  has  the  integra- 
tion of  industry  on  the  circulation  of  money? 


QUIZ  QUESTIONS  435 

89.  Show  how  foreign  trade  may  result  in  a  special 
demand  for  gold. 

90.  Show  how  contracts  sometimes  affect  the  demand 
for  money. 

91.  Does  the  use  of  money  as  a  store  of  value  affect 
the  demand? 

92.  What  effect  upon  the  demand  for  money  arises 
from  insecurity  of  contracts  and  property? 

93.  Under  what  circumstances  may  it  be  advisable  for 
persons  to  hoard  money? 

94.  Is  hoarding  a  cause  or  an  effect  of  a  panic? 

95.  Define  "hoarding."     What  is  its  effect  on  the 
value  of  money?    What  are  some  of  the  injurious  in- 
direct effects  of  a  bank  failure  connected  with  money? 

96.  What  is  the  essential  difference  between  a  private 
and  a  bank  store  of  money? 

97.  Is  the  money  in  the  Government  Treasury  a 
hoard? 

98.  Does  the  demand  for  money  always  fall  equally 
upon  different  varieties  of  money? 

99.  Give   illustrations    of   seasonable    demands    for 
money. 

100.  How  far  does  international  trade  create  a  de- 
mand for  money? 

101.  What  are  the  bad  effects  of  a  premium  on  gold? 

102.  Name  some  reasons  why  the  demand  for  money 
is  very  irregular. 

103.  What  is  the  uncertain  element  in  the  supply  of 
money? 

104.  Why  is  gold  practically  the  only  elastic  element 
in  our  currency? 

105.  Does  the  quantity  of  gold  actually  produced  in 
a  country  determine  the  supply  in  that  country? 

106.  What  factors  determine  the  supply  of  gold? 


436  MONEY  AND  BANKING 

107.  Explain  how  the  utility  of  gold  has  little  connec- 
tion with  its  quantity. 

108.  What  are  the  advantages  of  an  increased  supply 
of  money? 

109.  Why  are  the  temporary  results  of  a  change  in 
the  money   supply  likely  to  be   serious   even  though 
ultimately  the  effect  may  be  nil? 

110.  Trace  the  history  of  a  brick  of  new  gold  and 
its  effects. 

111.  Why  does  not  the  circulation  of  new  gold  con- 
tinue to  raise  prices  indefinitely? 

112.  What  would  be  the  effect  on  prices  if  the  miner 
should  choose  to  hold  the  gold  coins  or  paper  money 
equivalent  for  the  gold  which  has  increased  the  money 
supply  of  the  country? 

113.  What  is  the  effect  if  the  miner  deposits  the  new 
gold  in  a  bank?     Show  how  the  effect  of  new  gold 
spreads  throughout  the  world.     What  advantage  has 
the  country  producing  gold  over  other  countries? 

114.  What  would  be  the  effect  of  an  issue  of  paper 
money;  compared  with  gold? 

115.  How  is  it  possible  to  determine  how  much  money 
is  needed  by  a  country? 

116.  What  difficulties  arise  from  the  facts  that  price 
changes  are  not  synchronous? 

117.  Show  how  rising  prices  stimulate  industry. 

118.  Why  is  not  an  increase  in  the  supply  of  money 
always  an  unqualified  benefit? 

119.  Give  some  illustrations  of  the  universal  law  of 
rhythm. 

120.  What  is  the  consequence  of  the  cumulative  effect 
of  economic  forces? 


QUIZ  QUESTIONS  437 


CHAPTER  VIII 

121.  Explain   how   every    debtor   has    sold    money 
"short." 

122.  How  are  the  shorts  "squeezed"  in  the  money 
market? 

123.  Explain  why  prices  of  stocks  may  decline  so 
suddenly? 

124.  What  effect  will  the  better  education  of  the 
people  in  financial  affairs  have  upon  the  fluctuations  in 
values? 

125.  What  is  meant  by  the  general  price  level? 

126.  What  is  a  price  table? 

127.  Why  should  a  price  table  not  be  confined  to  a 
few  commodities? 

128.  How  are  price  tables  constructed? 

129.  For  what  purpose  is  "weighting"  of  price  tables 
used? 

130.  What  are  the  advantages  of  "weighting"? 

131.  Why  does  the  Faulkner  Price  table  show  prices 
to  be  so  high  during  the  Civil  War? 

132.  What  are  Index  Numbers?    Prepare  a  chart 
illustrating  the  rhythmic  swings  of  prices.     Account  for 
the  greater  swings. 

133.  Describe  some  of  the  important  index  numbers 
prepared  by  European  statisticians. 

134.  What  are  the  most  important  forces  to  be  reck- 
oned with  in  forecasting  changes  of  the  general  price 
level? 

135.  What  is  the  effect  of  excessive  saving  on  pros- 
perity?    State  the  rule  for  predicting  general  price 
changes. 


438  MONEY  AND  BANKING 

CHAPTER  IX 

136.  What  is  the  'difference  between  domestic  and 
foreign  exchange? 

137.  How  may  payments  be  made  without  the  use 
of  cash? 

138.  How  do  banks  facilitate  payments  without  the 
use  of  cash? 

139.  Why  is  New  York  Exchange  so  universally 
acceptable? 

140.  How  do  banks  all  over  the  country  get  their 
power  to  sell  New  York  exchange? 

141.  Tell  how  the  banks  handle  New  York  exchange. 

142.  How  do  banks  settle  balances  between  them- 
selves? 

143.  What  are  the  items  of  expense  in  shipping 
currency? 

144.  How  do  the  United  States  subtreasuries  assist 
the  banks  in  the  settlements  of  balances? 

145.  How  is  the  price  of  New  York  exchange  de- 
termined? 

146.  What  is  the  significance  of  rates  of  domestic 
exchange?     Explain  why  it  is  impossible  for  a  com- 
munity to  lose  all  its  cash  in  the  settlement  of  balances  ? 

147.  How  does  the  clearing  house  principle  apply  to 
domestic  and  foreign  exchange? 

148.  How  may  the  use  of  cash  be  eliminated  even  in 
the  settlement  of  balances? 

149.  Why  are  the  movements  of  gold  so  important? 

150.  What  is  the  economic  function  of  the  dealer  in 
foreign  exchange? 

151.  How  do  the  foreign  exchange  dealers  really 
loan  working  capital  to  their  customers? 


QUIZ  QUESTIONS  439 

152.  Why  are  bankers  willing  to  purchase  drafts  of 
exporters  ? 

153.  Why  are  New  York  hanks  always  willing  to  pur- 
chase foreign  drafts? 

154.  Define  sterling  exchange. 

155.  If  the   English   pound  sterling   contains   113 
grains,  how  is  it  possible  to  determine  its  value  in  United 
States  money? 

156.  How  is  the  cost  of  shipping  gold  across  the 
Atlantic  calculated? 

157.  What  is  the  minimum  price  of  demand  sterling 
exchange? 

158.  Why  is  it  impossible  under  normal  conditions 
for  sterling  exchange  to  sell  higher  than  $4.8865? 

159.  Explain  the  conditions  which  made  it  possible 
for  the  price  of  demand  sterling  to  fall  to  $4.83  in 
March,  1907. 

160.  Describe  the  English  gold  bullion  market. 

161.  How  was  it  possible  for  the  Bank  of  France  to 
maintain  a  3  per  cent,  discount  rate  in  1906,  while  funds 
could  be  loaned  in  London  at  6  per  cent.? 

162.  What  is  the  significance  of  shipments  of  gold 
to  foreign  countries? 

163.  Mention   certain   peculiarities   of  our   foreign 
commerce. 

164.  What  are  the  "invisible"  items  of  foreign  trade? 

165.  Show  how  capital  moves  from  one  country  to 
another. 

166.  Show  that  interest  and  dividend  payments  to 
foreigners  affect  the  so-called  foreign  trade  balance. 

167.  What  effect  upon  the  demand  for  foreign  ex- 
change is  exerted  by  the  fact  that  American  merchandise 
is  carried  in  foreign  ships? 


44,0  MONEY  AND  BANKING 

168.  How  do  American  tourists  in  Europe  affect  the 
demand  for  foreign  exchange? 

169.  What  points  are  worth  mentioning  in  a  daily 
newspaper  article  on  foreign  exchange? 

170.  Explain  the  "London  Settlement" 

171.  What  is  meant  by  "cables"?    By  speculation  in 
foreign    exchange?    By    "covering   movement"?    By 
manipulation? 

172.  Explain    the    several    varieties    of    exchange. 
How  are  their  values  determined? 

173.  What  is  demand  sterling  and  why  do  different 
demand  bills  sell  at  different  prices?    At  what  rate  of 
interest  are  long  bills  discounted? 

174.  What  is  the  business  of  London  bill  brokers? 

175.  What  is  the  effect  on  the  price  of  exchange  of 
an  issue  of  60-day  finance  bills?    The  effect  60  days 
later? 

176.  Upon  what  does  profit  on  finance  bills  depend? 
Show  that  their  issue  is  equivalent  to  borrowing  money 
abroad.     What  effect  does  their  issue  have  upon  rates 
of  interest?    What   advantage   does   London   possess 
over  other  financial  centers? 

177.  What  are  the  advantages  to  a  bank  from  having 
a  foreign  department? 

178.  Why  is  a  man  who  wishes  to  travel  abroad  likely 
to  transfer  his  deposit  account  to  a  bank  which  can  sell 
him  a  letter  of  credit?     Suppose  you  have  a  letter  of 
credit  issued  on  a  deposit  account.     If  you  asked  for 
£10  at  the  Deutsche  Bank  in  Berlin  on  a  day  when 
sterling  was  quoted  at  M.  20.43,  how  much  would  you 
realize  in  marks?    For  how  much  would  your  deposit 
account  be  debited  when  the  draft  reached  home,  if  ster- 
ling exchange  was  selling  at  $4.86? 

179.  What  are  the  advantages  of  using  a  commercial 


QUIZ  QUESTIONS  441 

letter  of  credit?    Why  are  banks  all  over  the  world 
eager  to  cash  letters  of  credit? 

180.  Suppose  I  want  to  borrow  .£10,000  for  90  days. 
Demand   sterling   sells    at   $4.88    and   the    Bank   of 
England  rate  is  5  per  cent.     At  the  end  of  90  days  de- 
mand sterling  sells  at  $4.84.     I  can  loan  funds  at  home 
for  6  per  cent.,  what  profit  can  I  make  by  selling  finance 
bills? 

181.  A  Philadelphia  banker  sells  a  draft  for  240,175 
Kronen  on  Vienna.     By  cabling  to  Vienna  he  learns 
that  sterling  exchange  is  worth  24  Kronen  17%  heller 
(100  heller  =  1  Kronen).     The  current  price  for  de- 
mand sterling  in  Philadelphia  is  $4.865.     What  profit 
can  be  made  by  buying  sterling  to  cover  if  he  sold  the 
draft  on  Vienna  for  $.2030  per  Kronen? 

182.  Would  there  be  any  profit  in  an  arbitrage  trans- 
action at  the  following  quotations? 

Sterling  in  New  York    $4.885 

Francs  in  London  25.10 

Francs  in  New  York         5.16  %  less  1-32 

Show  the  profit  on  $1,000  invested  in  the  arbitrage 
transaction. 

CHAPTER  X 

183.  What  is  the  world's  stock  of  gold  and  silver? 

184.  How  much  silver  is  it  estimated  that  the  world 
has  produced?    Why  did  mining  decline  after  the  fall 
of  the  Roman  Empire? 

185.  How  were  wars  financed  during  the  Feudal 
Period? 

186.  What  was  the  effect  produced  by  the  new  stock 
of  silver  from  America? 


442  MONEY  AND  BANKING 

187.  Show  the  effect  of  American  silver  upon  eco- 
nomic conditions  in  Europe. 

188.  What  caused  the  new  money  to  get  into  circula- 
tion? 

189.  Describe  the  discoveries  of  gold  in  California 
and  Australia  in  the  Nineteenth  Century. 

190.  What  were  the  effects  produced  by  the  gold  dis- 
coveries in  California? 

191.  What  discoveries  of  gold  were  made  in  1889  and 
a  few  years  later? 

192.  Whence  comes  the  largest  amount  of  gold  at  the 
present  time? 

193.  Explain  the  origin  of  gold. 

194.  Describe  placer  mining. 

195.  What  improvements  have  been  made  upon  old 
methods? 

196.  Describe  the  method  of  dredging. 

197.  Estimate  the  economic  importance  of  the  cyanide 
and  chloride  processes. 

198.  In   a   general   way   what   have   been   the   net 
financial  results  from  gold  mining? 


CHAPTER  XI 

199.  What  is  bimetallism? 

200.  What  are  some  of  the  difficulties  of  maintaining 
a  bimetallic  standard?     Why  did  the  difficulties  arise 
only  in  the  Nineteenth  Century? 

201.  What  are  the  advantages  of  bimetallism? 

202.  Give  the  argument  in  favor  of  international 
bimetallism. 

203.  In  what  ways  do  silver  standard  countries  suffer 
economically? 


QUIZ  QUESTIONS  443 

204.  What  early  attempts  were  made  to  inflate  the 
currency? 

205.  What   is   meant   by   the   "demonetization"   of 
silver? 

206.  What  was  the  Latin  Union? 

207.  What  caused  silver  to  decline  in  price  so  sud- 
denly after  1870  ?     Under  what  circumstances  was  silver 
demonetized  in  the  United  States? 

208.  Why  were  the  silver  purchase  acts  of  1878  and 
1900  passed? 

209.  What  was  the  connection  between  the  Sherman 
Act  and  the  panic  of  1893? 

210.  How  did  the  purchase  of  silver  embarrass  the 
Treasury? 

211.  What  was  the  attitude  of  the  banks  toward  the 
silver  dollar? 

212.  Explain  the  origin  of  the  silver  certificate. 

213.  What  was  the  currency  situation  in  the  United 
States  in  1890? 

214.  What  is  the  importance  of  the  gold  reserve  in 
the  United  States  Treasury? 

215.  What  was  the  greatest  official  act  of  President 
Cleveland's  second  administration? 

216.  Upon  what  authority  did  President  Cleveland 
issue  bonds? 

217.  Why  was  it  necessary  to  issue  so  many  bonds 
in  1894-1 895? 

218.  How  were  the  exports  of  gold  finaly  stopped? 

219.  Why  did  the  panic  of  1893  fail  to  give  the  public 
a  wholesome   lesson   in   finance?     Was   it   caused   by 
a  scarcity  or  a  plethora  of  money? 

220.  Explain  the  origin  of  the  free  silver  movement. 

221.  What  arguments  were  used  by  the  advocates  of 
free  silver  to  convince  the  farmer? 


MONEY  AND  BANKING 

222.  What  argument  was  used  in  order  to  convince 
the  workingman? 

223.  What  arguments  were  used  by  the  advocates  of 
gold? 

224.  Show  the  fallacy  involved  in  the  "50-cent  dollar" 
argument. 

225.  What  would  have  been  the  effect  of  a  free 
coinage  law  upon  prices? 

226.  Describe  the  real  debtor  and  creditor  classes. 

227.  How  was  the  silver  question  finally  solved? 

228.  Describe    the    "gold-exchange"    standard    of 
Mexico. 

CHAPTER  XII 

229.  What  is  a  credit?    How  do  credits  originate? 

230.  Show  how  credit  is  of  great  importance  in  in- 
dustry. 

231.  What  is  the  function  of  commercial  banking? 

232.  Describe  the  bond  and  mortgage. 

233.  Show  how  the  use  of  credit  facilitates  the  lumber 
industry. 

234.  Describe  the  characteristics  of  timber  bonds. 

235.  Why  is  there  such  a  difference  in  the  interest 
rates  of  different  classes  of  bonds? 

236.  What  are  the  advantages  of  long-time  borrow- 
ing? 

237.  Show  how  credit  economizes  the  use  of  gold. 

238.  What  danger  lies  in  the  liquidation  of  credits? 

239.  What  effect  have  the  commercial  paper  houses 
on  the  credit  system? 

240.  What  qualities  must  credit  have  in  order  to 
circulate  as  a  medium  of  exchange? 

241.  Compare  the  two  forms  of  bank  circulating 
credit. 


QUIZ  QUESTIONS  445 

242.  How  is  a  deposit  credit  utilized?    What  kind  of 
bank  credit  do  thickly  settled  communities  use? 

243.  What  is  meant  by  the  elasticity  of  deposit  credit? 
When  will  deposit  credits  depreciate?    What  causes 
credits  to  be  liquidated? 

244.  Show  how  gold  is  the  basis  of  all  credit. 

245.  What  are  the  reserve  requirements  of  the  Na- 
tional Bank  Act? 

246.  How  much  reserve  should  a  bank  keep? 

247.  How  is  credit  an  element  of  great  danger  in 
panics? 

248.  Why  is  credit  a  subject  well  worthy  of  investiga- 
tion? 

CHAPTER  XIII 

249.  What  is  the  general  effect  of  the  use  of  credit 
on  prices? 

250.  Describe  the  various  effects  of  the  different 
kinds  of  credit  on  prices? 

251.  Show  how  transactions  may  be  settled  without 
the  use  of  money  at  all. 

252.  Show  how  a  lessened  demand  for  money  causes 
a  rise  in  prices. 

253.  What  effect  does  an  issue  of  national  bank  notes 
have  upon  prices? 

254.  Explain  the  difference  in  circulation  of  bank 
notes  and  checks. 

255.  Has  government  credit  money  a  greater  or  less 
effect  on  prices  than  bank  notes? 

256.  What  is  the  relation  between  credit  and  specula- 
tion?   Differentiate  between  legitimate  and  illegitimate 
speculation. 

257.  How  may  speculation  be  both  the  cause  and 
effect  of  a  rise  of  prices? 


446  MONEY  AND  BANKING 

258.  Describe  the  conditions  which  cause  a  contrac- 
tion of  credit. 


CHAPTER  XIV 

259.  Name  the  varieties  of  government  credit  cur- 
rency. 

260.  What  is  the  essential  element  in  fiat  money? 

261.  What  are  the  factors  determining  the  value  of 
credit  money? 

262.  What  is  the  danger  in  the  use  of  credit  money? 
What  devices  are  used  to  maintain  the  value  of  credit 
money? 

263.  If  an  issue  of  credit  money  is  excessive,  what 
will  be  the  effect  on  its  value? 

264.  What  devices  are  used  to  maintain  the  value  of 
credit  money? 

265.  Give  an  argument  in  favor  of  government  credit 
money. 

266.  What  are  some  of  the  difficulties  of  adjusting 
the  supply  of  government  credit  money? 

267.  What  was  the  feeling  of  the  people  regarding 
government  issues  before  1861? 

268.  Why  are  government  bonds  not  credit  money? 
What  problem  was  raised  by  the  financing  of  the  Civil 
War? 

269.  What  are  some  of  the  disadvantages  of  govern- 
ment debt? 

270.  Why  are  notes  a  greater  element  of  weakness  in 
government  finance  than  bonds? 

271.  Contrast  government  borrowing  with  that  of 
private  concerns. 

272.  If  an  issue  of  credit  money  is  excessive,  what 
will  be  the  effect  on  its  value? 


QUIZ  QUESTIONS  447 

CHAPTER  XV 

273.  Classify  the   productive  industries   into   three 
groups. 

274.  Recapitulate   the   fundamental   principles   of 
exchange. 

275.  Show  that  a  credit  is  a  contract  to  pay  money. 

276.  What  is  the  business  of  a  bank? 

277.  In  what  two  ways  do  banks  supply  a  medium  of 
exchange? 

278.  Explain  why  banking  is  a  quasi-public  function? 

279.  How  does  the  bank  act  as  agent  between  the 
capitalist  and  entrepreneur?     Explain  how  the  bank  is 
a  distributer  of  capital. 

280.  What  banking  principle  is  it  the  violation  of 
which   causes   a   large   proportion    of   bank   failures? 
Name  three  reasons  why  banks  should  not  loan  funds  to 
be  converted  into  fixed  capital. 

281.  Trace  the  evolution  of  the  two  main  functions 
of  banking.     Contrast  the  Bank  of  Amsterdam  with 
the  Bank  of  England. 

282.  What  are  some  of  the  peculiar  privileges  of 
bankers  ? 

283.  Disprove  the  statement  that  "banks  create  capi- 
tal." 

284.  From  what  sources  does  a  bank  obtain  its  capital 
and  credit? 

285.  What  are  the  three  essential  banking  operations  ? 

286.  How  is  the  banker  the  "arbiter  of  investment"? 

CHAPTER  XVI 

287.  Does  a  bank  lend  credit  or  money?     Show  that 
credit  as  a  medium  of  exchange  is  superior  to  money. 


448  MONEY  AND  BANKING 

288.  Show  how  credit  promotes  the  production  of 
goods. 

289.  How  do  banks  create  credits? 

290.  Why  is  bank  credit  preferable  to  cash? 

291.  Show  how  bank  credit  passes  from  hand  to  hand 
without  being  liquidated. 

292.  Show  the  similarity  between  checks  and  bank 
notes. 

293.  On  what  does  the  earning  power  of  a  bank  de- 
pend?   Does  the  National  Bank  Act  limit  the  amount 
of  loans  a  bank  may  make? 

294.  Does  it  make  any  difference  to  a  bank  whether 
it  loans  cash  or  credit?     Illustrate  the  point  by  an  ex- 
ample. 

295.  Why  is  the  control  of  great  stores  of  cash  so 
great  a  prize  in  Wall   Street?     A  national  bank  in 
Kalamazoo,  Michigan,  receives  a  cash  deposit  of  $1,000 
which  is  left  for  one  year  intact,  no  checks  being  drawn 
against  it.     The  bank  has  no  difficulty  in  loaning  to  its 
own  customers  at  6  per  cent.     These  customers  make 
all  their  payments  by  check  and  deposit  all  their  receipts 
in  the  bank.     Calculate  the  gross  profit  which  the  bank 
can  make  on  the  $1,000  deposit,  leaving  out  of  account 
all  expenses  of  doing  business. 

296.  What  factors  determine  the  amount  of  deposit 
currency  available  in  this  country  at  any  given  time? 
By  what  means  might  the  maximum  limit  to  the  amount 
be  raised? 

297.  Show  how  the  lack  of  cooperation  between  the 
banks  causes  them  to  lose  part  of  their  reserves. 

298.  By  what  methods  may  a  bank  replenish   its 
reserve? 

299.  What  is  a  secondary  reserve?    Is  there  any 
danger  in  this  policy? 


QUIZ  QUESTIONS  449 

300.  Do  bonds  constitute  a  reliable  reserve? 

301.  How  did  the  Aldrich-Vreeland  Act  make  bonds 
a  valuable  asset  in  a  panic?     (Also  see  Appendix  I.) 

CHAPTER  XVII 

302.  How  does  a  bank  statement  differ  from  a  mer- 
cantile form? 

303.  How  does  the  statement  of  the  national  banks 
prove  the  validity  of  the  deposit  currency  theory?     How 
much  deposit  currency  is  there  in  the  United  States? 

304.  Why  do  the  resources  and  liabilities  exactly 
balance? 

305.  What  do  the  items  on  the  liability  side  signify? 
How  do  changes  in  the  values  of  resources  affect  the 
statement? 

306.  What  are  "concealed  assets"?    Are  they  good 
policy? 

307.  Distinguish  between  discounting  and  loaning. 

308.  What  is  an  over-draft? 

309.  Where  do  the  securities  held  as  collateral  on 
loans  appear? 

310.  How  are  the  deposits  of  the  United   States 
Government  secured? 

311.  Why   do  banks   sometimes   carry   government 
bonds  in  their  own  vaults? 

312.  What  is  meant  by  the  premium  on  United  States 
bonds? 

313.  What  is  included  under  bonds,  securities,  etc., 
and  why  has  this  item  increased  greatly  in  recent  years? 

314.  Are  banks  usually  the  owners  of  the  large  build- 
ings in  which  their  offices  are  situated? 

315.  What  is  the  law  regarding  the  holding  of  real 
estate  by  a  bank? 

VII— 29 


450  MONEY  AND  BANKING 

316.  What  is  meant  by  the  item  "due  from  national 
banks"? 

317.  What  is  an  "approved  reserve  agent"? 

318.  What  are  cash  items? 

319.  Why  do  national  banks  seek  to  have  on  hand  as 
few  bank  notes  as  possible? 

320.  What  are  legal  tender  notes? 

321.  What  is  the  Redemption  Fund? 

322.  What  is  included  under  "due  from  the  United 
States  Treasury"? 

CHAPTER  XVIII 

323.  Why  is  the  mimimum  capital  of  a  bank  propor- 
tioned to  the  size  of  the  city  in  which  it  is  located? 
Theoretically  how  large  should  the  capital  of  a  bank  be? 

324.  What  is  the  double  liability  feature  of  bank 
stocks?    Why  is  the  above  distinction  made  between 
bank  and  other  stocks?    How  is  it  possible  for  the 
capital  of  a  bank  to  be  really  fictitious? 

325.  What  is  the  purpose  of  the  surplus?    What  is 
the  requirement  of  the  National  Bank  Act  regarding 
surplus?    Why  do  some  banks  start  with  a  surplus? 
What  is  meant  by  the  "book- value"  of  bank  stocks? 

326.  What  disposition  is  ultimately  made  of  the  item 
"undivided  profits"  ? 

327.  What  inducement  is  there  for  the  banks  to  take 
out  circulation? 

328.  Explain  the  item  "State  Bank  Notes  Outstand- 
ing." 

329.  Explain  the  item  "individual  deposits."     What 
is  a  certificate  of  deposit? 

330.  Under  what   conditions   does  the   government 
deposit  in  national  banks? 


QUIZ  QUESTIONS  451 

331.  Explain  the  item  "bonds  borrowed." 
382.  What  is  the  difference  between  American  and 
European  banking  in  the  matter  of  rediscounting? 

333.  What  are  the  "bills  payable"  of  a  bank? 

334.  What  is  the  effect  of  certifying  a  check? 

335.  What  is  a  "cashier's  check"? 

CHAPTER  XIX 

336.  What  five  institutions  are  called  "banks"? 

337.  What  is  the  difference  between  national  and 
state  banks? 

338.  What  is  the  principal  business  of  large  private 
banks? 

339.  Describe  "underwriting." 

340.  What  is  the  difference  between  the  trust  com- 
pany and  a  bank?     How  did  the  trust  company  get  its 
name? 

341.  Are  trust  companies  required  to  keep  reserves? 

342.  What  is  the  nature  of  the  deposits  in  trust  com- 
panies? 

343.  What  departments  are  required  in  a  trust  com- 
pany? 

344.  What  are  the  functions  of  a  trust  company  as 
individual  trustee? 

345.  Describe  the  corporate  trusts  of  a  trust  company. 

346.  Why  is  a  savings  bank  really  not  a  bank  at  all? 

347.  Describe  the  organization  of  a  bank. 

348.  Describe  the  evolution  of  a  bank  in  a  small  town. 

349.  Where  is  ultimate  authority  located  in  an  in- 
corporated bank? 

350.  What  are  the  requirements  for  directors  named 
in  the  National  Bank  Act?    What  is  the  penalty  on 
directors  if  they  allow  the  law  to  be  violated? 


452  MONEY  AND  BANKING 

351.  What  considerations  govern  the  choice  of  di- 
rectors? 

352.  According  to  the  courts,  what  is  the  responsi- 
bility  of   bank    directors?     How    may    the    directors 
ascertain  the  true  condition  of  the  bank? 

353.  Of  what  value  is  the  plea  of  ignorance? 

354.  Can  directors  rely  implicitly  on  the  reports  of 
national  examiners?    What  two  types  of  loans  should 
directors  be  familiar  with? 

355.  What  should  be  the  attitude  of  bank  directors 
toward  loans  to  officers  and  other  directors? 

356.  What  are  the  duties  of  the  president? 

357.  Who  is  the  chief  executive  officer  of  a  bank? 
What  is  the  importance  of  the  credit  department  of  a 
bank? 

358.  What  are  the  duties  of  the  paying  teller?    Dis- 
count clerk? 

359.  What  are  the  duties  of  the  receiving  teller? 
From  what  four  sources  do  funds  come  into  a  bank? 

360.  What  are  the  duties  of  the  note  teller? 

361.  Describe  the  work  of  the  discount  clerk  and  show 
why  he  is  busy  during  a  period  of  active  speculation. 

362.  Mention  the  important  books  kept  by  a  bank. 

363.  What  is  the  law  with  regard  to  collections? 
What  risk  is  connected  with  a  tramp  collection? 

364.  What  is  the  responsibility  of  a  collecting  bank? 

365.  What  is  the  expense  of  collecting  out-of-town 
checks?    What  schemes  have  been  proposed  for  lessen- 
ing the  expense  of  collecting  country  checks? 

366.  What   is    the    English   method    of   collecting 
country  checks? 


QUIZ  QUESTIONS 


CHAPTER  XX 

367.  Distinguish   between   general  and  special   de- 
posits. 

368.  How  did  the  Legal  Tender  Acts  work  a  hard- 
ship to  the  depositors  during  the  War?    How  far  is  a 
bank  responsible  for  special  deposits? 

369.  What  advantages  do  the  safety  deposit  vaults 
bring  to  a  bank? 

370.  What  are  the  inducements  offered  to  depositors 
by  the  banks? 

371.  Describe  the  difficulties  in  the  way  of  establish- 
ing a  new  bank. 

372.  Why  are  depositors  loyal  to  old  and  conservative 
banks? 

373.  When  do  depositors  practice  the  "kiteing"  of 
checks? 

374.  Illustrate  the  method  of  "kiteing." 

375.  Show  how  the  title  to  deposit  checks  often  be- 
comes an  important  question. 

376.  Give  an  illustration  of  a  case  of  disputed  owner- 
ship. 

377.  What  is  the  law  regarding  the  acceptance  of 
deposits  by  insolvent  banks? 

378.  What  risk  does  a  holder  run  by  retaining  a  check 
too  long? 

379.  What  is  meant  by  "reasonable  time"  in  the  case 
of  a  local  bank? 

380.  What  recourse  has  the  holder  if  a  bank  refuses 
to  pay  a  check? 

381.  Can   a   depositor   stop   payment   on   a   check? 
What  effect  has  the  death  of  a  depositor  upon  checks 
not  yet  paid? 


454.  MONEY  AND  BANKING 

382.  Can  a  bank  pay  a  check  if  funds  to  the  credit  of 
the  depositor  are  insufficient? 

383.  What  is  a  bank's  liability  in  the  case  of  a  forged 
check? 

384.  May  a  bank  pay  a  post-dated  check  before  it  is 
due? 

385.  What  is  the  effect  of  the  fact  that  the  relation 
between  the  bank  and  the  depositor  is  that  of  debtor 
and  creditor?    What  is  meant  by  "set-off"? 

386.  If  a  bank  holds  a  depositor's  unsecured  note  and 
the  depositor  fails,  what  right  has  the  bank  to  his 
deposit? 

387.  If  a  bank  fails  may  a  depositor  pay  his  note  to 
the  bank  by  a  check  on  his  deposit? 

388.  Show  that  the  "set-off"  may  make  failures  ap- 
pear worse  than  they  really  are. 

389.  Illustrate  the  foregoing  by  a  concrete  case. 

390.  Show  how  banks  sometimes  protect  themselves 
against  loss  through  a  borrower's  insolvency. 


CHAPTER  XXI 

391.  What  two  qualities  are  essential  to  the  making 
of  the  banker? 

392.  What  are  meant  by  investment  loans? 

393.  Under  what  conditions   are   investment   loans 
good  banking  loans? 

394.  What  are  industrial  loans?     Show  how  they  are 
secured.    What  are  re-discounts? 

395.  What  is  meant  by  "Capital"  loans? 

396.  Should  a  bank  loan  a  concern  money  for  the 
construction  of  a  plant? 

397.  What  corporations  lend  money  on  mortgages? 


QUIZ  QUESTIONS  465 

398.  How  are  the  loans  classified  in  the  reports  to 
the  Comptroller? 

399.  What  changes  have  taken  place  in  ten  years  in 
the  proportion  of  the  demand  loans? 

400.  What  does  "double  name  paper"  represent?     Is 
this  paper  much  used  in  large  cities? 

401.  Distinguish   between   "trade"   and   "brokers* ' 
paper. 

402.  What  provisions  distinguish  the  judgment  note? 

403.  Name  the  provisions  of  the  collateral  note  by 
which  the  bank  protects  itself  against  loss. 

404.  What  risk  is  involved  in  collateral  loans? 

405.  Explain  what  is  meant  by  legal  rate  of  interest. 

406.  How  are  call  loan  rates  of  over  100  per  cent, 
consistent  with  the  usury  laws? 

407.  WTiy  do  conservative  bankers  object  to  loaning 
on  book  accounts? 

408.  What  is  the  task  of  the  financial  manager  of 
an  enterprise? 

CHAPTER  XXII 

409.  What  classes  of  property  may  serve  as  collateral 
for  loans? 

410.  What  are  some  of  the  difficulties  of  using  mer- 
chandise as  collateral? 

411.  What  are  the  advantages  of  good  warehousing 
laws? 

412.  Show  that  loans  on  merchandise  are  a  legiti- 
mate function  of  banks. 

413.  What  was  the  early  practice  of  the  Corn  Ex- 
change Bank  of  New  York? 

414.  Why  is  merchandise  better  collateral  now  than 
formerly? 


456  MONEY  AND  BANKING 

415.  How  does  the  new  Uniform  Law  safeguard 
warehouse  receipts? 

416.  What  are  the  risks  involved  in  loaning  on  ware- 
house receipts? 

417.  What  are  the  responsibilities  of  a  warehouseman 
under  the  present  law? 

418.  How  is  the  issue  of  receipts  safeguarded? 

419.  What  protection  is  afforded  to  holders  of  re- 
ceipts ? 

420.  Is  garnishment  allowed? 

421.  What  is  the  penalty  for  the  illegal  issue  of  re- 
ceipts? 

422.  What  do  some  banks  substitute  for  warehouse 
receipts? 

CHAPTER  XXIII 

423.  When  did  credit  departments  appear  in  banks? 

424.  Name  the  sources  of  credit  information. 

425.  How  far  are  the  credit  agencies  to  be  depended 
upon? 

426.  What  are  the  duties  of  the  credit  man? 

427.  What  is  the  business  of  the  commercial  note 
broker? 

428.  What  changes  have  taken  place  in  the  commer- 
cial paper  business  recently? 

429.  Upon  what  do  the  demand  and  supply  of  com- 
mercial paper  depend? 

430.  Show  how  a  country  possesses  areas  of  high  and 
low  interest  rates. 

431.  What  four  inducements  may  a  dealer  in  com- 
mercial paper  offer  to  a  borrower? 

432.  What  is  the  best  guarantee  against  loss  furnished 
by  a  dealer  in  commercial  paper? 


QUIZ  QUESTIONS  457 

433.  What  is  the  usual  size  of  notes  handled  by 
dealers  in  commercial  paper?    How  are  they  quoted? 

CHAPTER  XXIV 

434.  What  were  the  characteristics  of  early  banking 
in  the  United  States? 

435.  What  was  the  relation  of  early  banks  with  the 
government? 

436.  Divide  the  history  of  United  States  banking  into 
four  periods. 

437-  Describe  some  of  the  banks  prior  to  the  First 
Bank  of  the  United  States. 

488.  What  are  the  dangers  of  permitting  banks  to 
loan  on  bank  stock? 

439.  What  were  some  of  the  features  of  the  First 
Bank  of  the  United  States? 

440.  Was  the  Bank  successful?    How  much  did  it 
lend  to  the  government? 

441.  On  what  grounds  was  the  First  Bank  of  the 
[United  States  objected  to? 

442.  Why  was  the  Second  Bank  of  the  United  States 
organized? 

443.  Compare  the   Second  with  the   First   United 
States  Bank. 

444.  How  was  the  Second  Bank  mismanaged? 

445.  Why  was  President  Jackson  opposed  to  the 
Bank? 

446.  What  argument  does  the  history  of  the  two 
Banks  of  the  United  States  furnish  against  a  central 
federal  bank? 

447.  Describe  the  Suffolk  Banking  System. 

448.  What  two  plans  of  note  issue  were  tried  in  New 
York  State? 


458  MONEY  AND  BANKING 

449.  Describe  the  New  York  Safety  Fund  System. 

450.  Describe  the  bond  deposit  or  free  banking  sys- 
tem. 

451.  Why  did  the  Safety  Fund  System  fail? 

452.  What  were  the  causes  of  the  failure  of  the  Free 
Banking  System?    Was  it  adopted  in  other  States? 
What  was  its  only  advantage  over  the  Safety  Fund 
System? 

453.  What  was  the  experience  of  other  states  with 
their  banks? 

454.  Describe  the  Bank  of  Indiana.     Why  was  it 
successful?    Describe  the  State  Bank  of  Ohio. 

CHAPTER  XXV 

455.  What  conditions  led  to  the  National  Bank  Act? 

456.  What  effect  did  the  Act  have  on  the  market  for 
[United  States  bonds? 

457.  Give  the  early  history  of  the  Act. 

458.  What  are  the  duties  of  the  Comptroller  of  the 
Currency? 

459.  Name  the  chief  provisions  of  the  Act? 

460.  Describe  the  issue  and  redemption  of  National 
bank  notes. 

461.  What  were  the  evils  of  the  national  banking 
system? 

CHAPTER  XXVI 

462.  Name  some  of  the  differences  between  a  bank 
note  and  a  deposit  currency. 

463.  What  are  the  limitations  of  the  deposit  currency? 

464.  Explain    how    the    present    system    intensifies 
stringencies  and  panics  at  certain  seasons. 


QUIZ  QUESTIONS  459 

465.  Show  that  the  danger  of  depleted  reserves  is 
acute  in  times  of  panic. 

466.  What  methods  have  been  used  to  counteract  the 
seasonal  stringencies  and  panics? 

467.  Why  is  the  circulation  of  bank  notes  inelastic? 

468.  Under  what  circumstances  does  the  bank-note 
circulation  increase? 

469.  What  are  the  disadvantages  of  the  lack  of  unit^ 
in  our  system? 

470.  What  is  the  importance  of  savings  banks? 

471.  Whence  comes  the  need  for  the  postal  savings 
banks? 

472.  What  are  the  arguments  for  and  against  the 
guarantee  of  bank  deposits? 

CHAPTER  XXVII 

473.  What  is  the  economic  function  of  Wall  Street? 

474.  Where  do  the  dealers  in  securities  get  their  work- 
ing capital? 

475.  Describe  the  method  of  making  a  collateral  loan. 

476.  How  do  the  banks  avoid  technical  over-certifi- 
cation? 

477.  What  restrictions  do  the  banks  make  on  collat- 
eral? 

478.  What  is  the  peculiarity  of  the  call  loan  rate  of 
interest? 

479.  Show  why  the  responsibilities  of  the  loan  clerk 
are  great  in  Wall  Street  banks. 

480.  What  are  undigested  securities? 

481.  How  does  the  state  of  the  bank  reserves  affect 
the  prices  of  securities? 

482.  What   advantage   would   come   from   dividing 
banks  into  two  classes — commercial  and  financial? 


460  MONEY  AND  BANKING 

483.  What  additional  privileges  should  be  given  to 
national  banks? 

484.  Why  is  it  proper  to  forbid  financial  banks  acting 
as  reserve  agents? 

CHAPTER  XXVIII 

485.  In  what  way  is  the  Secretary  of  the  Treasury 
compelled  to  assume  more  responsibility  than  belongs 
to  his  office? 

486.  How  does  the  United  States  Treasury  intensify 
monetary  stringencies? 

487.  Are  these  conditions  the  result  of  our  currency 
or  of  the  Treasury  laws? 

488.  What  expedients  have  been  used  by  Secretaries 
of  the  Treasury  to  mitigate  stringencies? 

CHAPTER  XXIX 

489.  Under  what  circumstances  was  the  Bank  of 
England  founded?     Describe  the  business  of  the  orig- 
inal Bank  of  England. 

490.  What  conditions  caused  the  development  of  the 
use  of  checks? 

491.  What  were  the  provisions  of  the  Bank  Act  of 
1844? 

492.  What  is  the  present  character  of  the  Bank  of 
England  note? 

493.  What  is  the  relation  of  the  Bank  of  England  to 
the  Government?     How  is  the  Bank  of  England  the 
center  of  the  banking  system  of  Great  Britain? 

494.  Describe  the  history  of  early  banking  in  France. 

495.  What  are  the  distinguishing  features   of  the 
Bank  of  France? 


QUIZ  QUESTIONS  461 

496.  To  what   extent  is   deposit  currency   used  in 
France? 

497.  What  security  is  behind  the  notes  of  the  Bank 
of  France? 

498.  Contrast  the  Bank  of  England  and  France  with 
reference  to  the  fundamental  principle  upon  which  they 
are  based. 

499.  Compare  the  Reichsbank  of  Germany  with  the 
Bank  of  England. 

500.  How  does  the  government  influence  the  Reichs- 
bank? 

501.  Show  that  the  Bank  of  Germany  is  modeled 
after  the  Bank  of  England. 

502.  What  reserves  is  the  Bank  of  Germany  required 
to  keep? 

CHAPTER  XXX 

503.  Name  the  chief  features  of  the  Canadian  Bank- 
ing System.     How  is  the  banking  business  extended? 

504.  What  is  the  security  back  of  Canadian  Bank 
notes? 

505.  How  does  the  anxiety  of  each  bank  to  keep  out- 
standing as  many  notes  as  possible  cause  rapid  redemp- 
tion of  the  notes? 

506.  Why  is  the  Canadian  system  so  elastic? 

507.  What  is  the  Canadian  theory  of  reserves? 

508.  What  are  the  advantages  of  branch  banking? 

509.  Describe  the  financial  details  of  the  moving  of 
the  Canadian  wheat  crop. 

510.  What  does  the  Canadian  farmer  receive  in  ex- 
change for  his  wheat? 

511.  Why  do  the  Canadian  banks  have  so  many 
branches  in  Chicago  and  New  York? 


462  MONEY  AND  BANKING 

512.  Describe  the  seasonal  fluctuations  of  the  amount 
of  Canadian  bank  notes. 

CHAPTER  XXXI 

513.  To  what  extent  is  our  present  currency  "inelas- 
tic"?    How  are  the  bad  effects  of  our  currency  mani- 
fested?   Does  our  present  currency  increase  or  diminish 
speculation?     Is  our  deposit  currency  inelastic?     What 
determines  the  amount  of  deposit  currency? 

514.  What  are  the  objections  to  United  States  notes? 
What  are  the  objections  to  bank  notes  based  on  United 
States  bonds?    Do  the  same  objections  apply  to  bank 
notes  based  on  state  and  municipal  bonds?     On  railroad 
bonds? 

515.  Do  you  think  that  the  banking  business  of  the 
country  should  be  administered  more  or  less  by  the  gov- 
ernment than  it  now  is?     What  obstacles  must  exist  to 
a  change  in  the  Sub-treasury  system?     Should  the  gov- 
ernment   depositories    pay    interest    on    government 
deposits  and  why?    Why  do  they  not  do  so  now? 

516.  How  much  reserve  should  a  bank  keep?     Should 
bank  reserves  be  rigid  or  flexible?    Why  should  a  re- 
serve be  kept  against  bank  notes?     In  what  respect  are 
our  reserve  laws  defective  and  dangerous?     Name  four 
possible  demands  for  cash  which  may  deplete  the  bank 
reserves. 

517.  Is  there  any  way  to  have  guaranteed  bank  de- 
posits without  incurring  the  danger  of  unsound  bank- 
ing? 

518.  What  objection  is  there  to  the  plan  permitting 
national  banks  to  have  trust  and  savings  departments? 
What  advantages?      What  is  the  danger  of  an  asset 


QUIZ  QUESTIONS  463 

currency  so  long  as  state  banks  and  trust  companies 
exist? 

519.  What  benefit  would  come  from  a  central  bank? 
What  prevents  the  United  States  from  becoming  a  great 
financial  center?    How  would  centralized  banking  make 
possible  a  clearing  house  for  country  checks?     How 
could  a  central  bank  prevent  failures  and  panics  ?     How 
could  it  increase  the  effectiveness  of  the  reserves? 

520.  Distinguish  between  necessary  trading,  legiti- 
mate and  illegitimate  speculation.     Show  how  illegiti- 
mate speculation  tends  to  increase  fluctuations  in  price. 

521.  Why    not    restrict    speculation    by    curtailing 
credit? 

522.  What  is  the  difference  between  Commercial  and 
Financial  banking?    Why  give  financial  banks  trust 
company  functions?     Show  how  publicity  would  check 
speculation.     Distinguish  between  working  and  fixed 
capital. 

523.  Why  should  not  a  bank  provide  fixed  capital  for 
industry?     How  does  the  National  Bank  Act  try  to 
prevent  the  banks  from  loaning  fixed  capital?    Does 
it  succeed? 


APPENDIX  I 

GOLD    STANDARD    ACT   OF    MARCH    14,    1900 

[PUBLIC — No.  39.] 

An  Act  To  define  and  fix  the  standard  of  value,  to  maintain  the  parity  of 
of  all  forms  of  money  issued  or  coined  by  the  United  States,  to  refund  the 
public  debt,  and  for  other  purposes. 

Be  it  enacted  by  the  Senate  and  House  of  Representatives  of 
the  United  States  of  America  in  Congress  assembled,  That  the 
dollar  consisting  of  twenty-five  and  eight-tenths  grains  of  gold 
nine-tenths  fine,  as  established  by  section  thirty-five  hundred  and 
eleven  of  the  Revised  Statutes  of  the  United  States,  shall  be  the 
standard  unit  of  value,  and  all  forms  of  money  issued  or  coined 
by  the  United  States  shall  be  maintained  at  a  parity  of  value 
with  this  standard,  and  it  shall  be  the  duty  of  the  Secretary  of 
the  Treasury  to  maintain  such  parity. 

SEC.  2.  That  United  States  notes,  and  Treasury  notes  is- 
sued under  the  Act  of  July  fourteenth,  eighteen  hundred  and 
ninety,  when  presented  to  the  Treasury  for  redemption,  shall  be 
redeemed  in  gold  coin  of  the  standard  fixed  in  the  first  section 
of  this  Act,  and  in  order  to  secure  the  prompt  and  certain  re- 
demption of  such  notes  as  herein  provided  it  shall  be  the  duty  of 
the  Secretary  of  the  Treasury  to  set  apart  in  the  Treasury  a 
reserve  fund  of  one  hundred  and  fifty  million  dollars  in  gold 
coin  and  bullion,  which  fund  shall  be  used  for  such  redemption 
purposes  only,  and  whenever  and  as  often  as  any  of  said  notes 
shall  be  redeemed  from  said  fund  it  shall  be  the  duty  of  the 
Secretary  of  the  Treasury  to  use  said  notes  so  redeemed  to 
restore  and  maintain  such  reserve  fund  in  the  manner  following, 
to  wit:  First,  by  exchanging  the  notes  so  redeemed  for  any 
gold  coin  in  the  general  fund  of  the  Treasury;  second,  by  ac- 
cepting deposits  of  gold  coin  at  the  Treasury  or  at  any  sub- 
VH-30  465 


466  APPENDIX 

treasury  in  exchange  for  the  United  States  notes  so  redeemed; 
third,  by  procuring  gold  coin  by  the  use  of  said  notes,  in 
accordance  with  the  provisions  of  section  thirty-seven  hundred 
of  the  Revised  Statutes  of  the  United  States.  If  the  Secretary 
of  the  Treasury  is  unable  to  restore  and  maintain  the  gold  coin 
in  the  reserve  fund  by  the  foregoing  methods,  and  the  amount 
of  such  gold  coin  and  bullion  in  said  fund  shall  at  any  time  fall 
below  one  hundred  million  dollars,  then  it  shall  be  his  duty  to 
restore  the  same  to  the  maximum  sum  of  one  hundred  and  fifty 
million  dollars  by  borrowing  money  on  the  credit  of  the  United 
States,  and  for  the  debt  thus  incurred  to  issue  and  sell  coupon 
or  registered  bonds  of  the  United  States,  in  such  form  as  he  may 
prescribe,  in  denominations  of  fifty  dollars  or  any  multiple 
thereof,  bearing  interest  at  the  rate  of  not  exceeding  three  per 
centum  per  annum,  payable  quarterly,  such  bonds  to  be  payable 
at  the  pleasure  of  the  United  States  after  one  year  from  the 
date  of  their  issue,  and  to  be  payable,  principal  and  interest,  in 
gold  coin  of  the  present  standard  value,  and  to  be  exempt  from 
the  payment  of  all  taxes  or  duties  of  the  United  States,  as  well 
as  from  taxation  in  any  form  by  or  under  State,  municipal,  or 
local  authority ;  and  the  gold  coin  received  from  the  sale  of  said 
bonds  shall  first  be  covered  into  the  general  fund  of  the  Treasury 
and  then  exchanged,  in  the  manner  hereinbefore  provided,  for 
an  equal  amount  of  the  notes  redeemed  and  held  for  exchange, 
and  the  Secretary  of  the  Treasury  may,  in  his  discretion,  use 
said  notes  in  exchange  for  gold,  or  to  purchase  or  redeem  any 
bonds  of  the  United  States,  or  for  any  other  lawful  purpose  the 
public  interests  may  require,  except  that  they  shall  not  be  used 
to  meet  deficiencies  in  the  current  revenues.  That  United  States 
notes  when  redeemed  in  accordance  with  the  provisions  of  this 
section  shall  be  reissued,  but  shall  be  held  in  the  reserve  fund 
until  exchanged  for  gold,  as  herein  provided ;  and  the  gold  coin 
and  bullion  in  the  reserve  fund,  together  with  the  redeemed 
notes  held  for  use  as  provided  in  this  section,  shall  at  no  time 
exceed  the  maximum  sum  of  one  hundred  and  fifty  million  dollars. 
SEC.  3.  That  nothing  contained  in  this  Act  shall  be  construed 
to  affect  the  legal-tender  quality  as  now  provided  by  law  of  the 


APPENDIX  467 

silver  dollar,  or  of  any  other  money  coined  or  issued  by  the 
United  States. 

SEC.  4.  That  there  be  established  in  the  Treasury  Depart- 
ment, as  a  part  of  the  office  of  the  Treasurer  of  the  United 
States,  divisions  to  be  designated  and  known  as  the  division  of 
issue  and  the  division  of  redemption,  to  which  shall  be  assigned, 
respectively,  under  such  regulations  as  the  Secretary  of  the 
Treasury  may  approve,  all  records  and  accounts  relating  to  the 
issue  and  redemption  of  United  States  notes,  gold  certificates, 
silver  certificates,  and  currency  certificates.  There  shall  be 
transferred  from  the  accounts  of  the  general  fund  of  the 
Treasury  of  the  United  States,  and  taken  up  on  the  books  of 
said  divisions,  respectively,  accounts  relating  to  the  reserve 
fund  for  the  redemption  of  United  States  notes  and  Treasury 
notes,  the  gold  coin  held  against  outstanding  gold  certificates, 
the  United  States  notes  held  against  outstanding  currency 
certificates,  and  the  silver  dollars  held  against  outstanding  silver 
certificates,  and  each  of  the  funds  represented  by  these  accounts 
shall  be  used  for  the  redemption  of  the  notes  and  certificates 
for  which  they  are  respectively  pledged,  and  shall  be  used  for 
no  other  purpose,  the  same  being  held  as  trust  funds. 

SEC.  5.  That  it  shall  be  the  duty  of  the  Secretary  of  the 
Treasury,  as  fast  as  standard  silver  dollars  are  coined  under 
the  provisions  of  the  Acts  of  July  fourteenth,  eighteen  hundred 
and  ninety,  and  June  thirteenth,  eighteen  hundred  and  ninety- 
eight,  from  bullion  purchased  under  the  Act  of  July  fourteenth, 
eighteen  hundred  and  ninety,  to  retire  and  cancel  an  equal 
amount  of  Treasury  notes  whenever  received  into  the  Treasury, 
either  by  exchange  in  accordance  with  the  provisions  of  this 
Act  or  in  the  ordinary  course  of  business,  and  upon  the  cancella- 
tion of  Treasury  notes  silver  certificates  shall  be  issued  against 
the  silver  dollars  so  coined. 

SEC.  6.  That  the  Secretary  of  the  Treasury  is  hereby 
authorized  and  directed  to  receive  deposits  of  gold  coin  with  the 
Treasurer  or  any  assistant  treasurer  of  the  United  States  in  sums 
of  not  less  than  twenty  dollars,  and  to  issue  gold  certificates 
therefor  in  denominations  of  not  less  than  twenty  dollars,  and 


468  APPENDIX 

the  coin  so  deposited  shall  be  retained  in  tfie  Treasury  and  held 
for  the  payment  of  such  certificates  on  demand,  and  used  for 
no  other  purpose.  Such  certificates  shall  be  receivable  for  cus- 
toms, taxes,  and  all  public  dues,  and  when  so  received  may  be 
reissued,  and  when  held  by  any  national  banking  association 
may  be  counted  as  a  part  of  its  lawful  reserve :  Provided,  That 
whenever  and  so  long  as  the  gold  coin  held  in  the  reserve  fund 
in  the  Treasury  for  the  redemption  of  United  States  notes  and 
Treasury  notes  shall  fall  and  remain  below  one  hundred  million 
dollars  the  authority  to  issue  certificates  as  herein  provided  shall 
be  suspended:  And  provided  further,  That  whenever  and  so 
long  as  the  aggregate  amount  of  United  States  notes  and  silver 
certificates  in  the  general  fund  of  the  Treasury  shall  exceed  sixty 
million  dollars  the  Secretary  of  the  Treasury  may,  in  his  dis- 
cretion, suspend  the  issue  of  the  certificates  herein  provided  for : 
And  provided  further,  That  of  the  amount  of  such  outstanding 
certificates  one-fourth  at  least  shall  be  in  denominations  of  fifty 
dollars  or  less:  And  provided  further,  That  the  Secretary  of 
the  Treasury  may,  in  his  discretion,  issue  such  certificates  in 
denominations  of  ten  thousand  dollars,  payable  to  order.  And 
section  fifty-one  hundred  and  ninety-three  of  the  Revised 
Statutes  of  the  United  States  is  hereby  repealed. 

SEC.  7.  That  hereafter  silver  certificates  shall  be  issued  only 
of  denominations  of  ten  dollars  and  under,  except  that  not  ex- 
ceeding in  the  aggregate  ten  per  centum  of  the  total  volume  of 
said  certificates,  in  the  discretion  of  the  Secretary  of  the 
Treasury,  may  be  issued  in  denominations  of  twenty  dollars, 
fifty  dollars,  and  one  hundred  dollars ;  and  silver  certificates  of 
higher  denomination  than  ten  dollars,  except  as  herein  provided, 
shall,  whenever  received  at  the  Treasury  or  redeemed,  be  retired 
and  canceled,  and  certificates  of  denominations  of  ten  dollars  or 
less  shall  be  substituted  therefor,  and  after  such  substitution, 
in  whole  or  in  part,  a  like  volume  of  United  States  notes  of 
less  denomination  than  ten  dollars  shall  from  time  to  time  be 
retired  and  canceled,  and  notes  of  denominations  of  ten  dollars 
and  upward  shall  be  reissued  in  substitution  therefor,  with  like 
qualities  and  restrictions  as  those  retired  and  canceled. 


APPENDIX  469 

SEC.  8.  That  the  Secretary,  of  the  Treasury  is  hereby 
authorized  to  use,  at  his  discretion,  any  silver  bullion  in  the 
Treasury  of  the  United  States  purchased  under  the  Act  of  July 
fourteenth,  eighteen  hundred  and  ninety,  for  coinage  into  such 
denominations  of  subsidiary  silver  coin  as  may  be  necessary  to 
meet  the  public  requirements  for  such  coin:  Provided,  That 
the  amount  of  subsidiary  silver  coin  outstanding  shall  not  at  any 
time  exceed  in  the  aggregate  one  hundred  millions  of  dollars. 
Whenever  any  silver  bullion  purchased  under  the  Act  of  July 
fourteenth,  eighteen  hundred  and  ninety,  shall  be  used  in  the 
coinage  of  subsidiary  silver  coin,  an  amount  of  Treasury  notes 
issued  under  said  Act  equal  to  the  cost  of  the  bullion  contained 
in  such  coin  shall  be  canceled  and  not  reissued. 

SEC.  9.  That  the  Secretary  of  the  Treasury  is  hereby  author- 
ized and  directed  to  cause  all  worn  and  uncurrent  subsidiary 
silver  coin  of  the  United  States  now  in  the  Treasury,  and  here- 
after received,  to  be  recoined,  and  to  reimburse  the  Treasurer 
of  the  United  States  for  the  difference  between  the  nominal  or 
face  value  of  such  coin  and  the  amount  the  same  will  produce 
in  new  coin  from  any  moneys  in  the  Treasury  not  otherwise 
appropriated. 

SEC.  10.  That  section  fifty-one  hundred  and  thirty-eight  of 
the  Revised  Statutes  is  hereby  amended  so  as  to  read  as  fol- 
lows: 

"Section  5138.  No  association  shall  be  organized  with  a  less 
capital  than  one  hundred  thousand  dollars,  except  that  banks 
with  a  capital  of  not  less  than  fifty  thousand  dollars  may,  with 
the  approval  of  the  Secretary  of  the  Treasury,  be  organized  in 
any  place  the  population  of  which  does  not  exceed  six  thousand 
inhabitants,  and  except  that  banks  with  a  capital  of  not  less 
than  twenty-five  thousand  dollars  may,  with  the  sanction  of  the 
Secretary  of  the  Treasury,  be  organized  in  any  place  the 
population  of  which  does  not  exceed  three  thousand  inhabitants. 
No  association  shall  be  organized  in  a  city  the  population  of 
which  exceeds  fifty  thousand  persons  with  a  capital  of  less  than 
two  hundred  thousand  dollars." 

SEC.  11.  That   the    Secretary    of   the   Treasury    is    hereby 


470  APPENDIX 

authorized  to  receive  at  the  Treasury  any  of  the  outstanding 
bonds  of  the  United  States  bearing  interest  at  five  per  centum 
per  annum,  payable  February  first,  nineteen  hundred  and  four, 
and  any  bonds  of  the  United  States  bearing  interest  at  four 
per  centum  per  annum,  payable  July  first,  nineteen  hundred  and 
seven,  and  any  bonds  of  the  United  States  bearing  interest  at 
three  per  centum  per  annum,  payable  August  first,  nineteen 
hundred  and  eight,  and  to  issue  in  exchange  therefor  an  equal 
amount  of  coupon  or  registered  bonds  of  the  United  States  in 
such  form  as  he  may  prescribe,  in  denominations  of  fifty  dollars 
or  any  multiple  thereof,  bearing  interest  at  the  rate  of  two 
per  centum  per  annum,  payable  quarterly,  such  bonds  to  be 
payable  at  the  pleasure  of  the  United  States  after  thirty  years 
from  the  date  of  their  issue,  and  said  bonds  to  be  payable, 
principal  and  interest,  in  gold  coin  of  the  present  standard  value, 
and  to  be  exempt  from  the  payment  of  all  taxes  or  duties  of  the 
United  States,  as  well  as  from  taxation  in  any  form  by  or 
under  State,  municipal,  or  local  authority:  Provided,  That 
such  outstanding  bonds  may  be  received  in  exchange  at  a  valua- 
tion not  greater  than  their  present  worth  to  yield  an  income  of 
two  and  one-quarter  per  centum  per  annum;  and  in  considera- 
tion of  the  reduction  of  interest  effected,  the  Secretary  of  the 
Treasury  is  authorized  to  pay  to  the  holders  of  the  outstanding 
bonds  surrendered  for  exchange,  out  of  any  money  in  the 
Treasury  not  otherwise  appropriated,  a  sum  not  greater  than 
the  difference  between  their  present  worth,  computed  as  afore- 
said, and  their  par  value,  and  the  payments  to  be  made  here- 
under  shall  be  held  to  be  payments  on  account  of  the  sinking 
fund  created  by  section  thirty-six  hundred  and  ninety-four  of 
the  Revised  Statutes:  And  provided  further,  That  the  two 
per  centum  bonds  to  be  issued  under  the  provisions  of  this  Act 
shall  be  issued  at  not  less  than  par,  and  they  shall  be  numbered 
consecutively  in  the  order  of  their  issue,  and  when  payment  is 
made  the  last  numbers  issued  shall  be  first  paid,  and  this  order 
shall  be  followed  until  all  the  bonds  are  paid,  and  whenever 
any  of  the  outstanding  bonds  are  called  for  payment  interest 
thereon  shall  cease  three  months  after  such  call;  and  there  is 


APPENDIX  471 

hereby  appropriated  out  of  any  money  in  the  Treasury  not 
otherwise  appropriated,  to  effect  the  exchanges  of  bonds  pro- 
vided for  in  this  Act,  a  sum  not  exceeding  one-fifteenth  of  one 
per  centum  of  the  face  value  of  said  bonds,  to  pay  the  expense 
of  preparing  and  issuing  the  same  and  other  expenses  incident 
thereto. 

SEC.  12.  That  upon  the  deposit  with  the  Treasurer  of  the 
United  States,  by  any  national  banking  association,  of  any 
bonds  of  the  United  States  in  the  manner  provided  by  existing 
law,  such  association  shall  be  entitled  to  receive  from  the  Comp- 
troller of  the  Currency  circulating  notes  in  blank,  registered 
and  countersigned  as  provided  by  law,  equal  in  amount  to  the 
par  value  of  the  bonds  so  deposited ;  and  any  national  banking  as- 
sociation now  having  bonds  on  deposit  for  the  security  of  circu- 
lating notes,  and  upon  which  an  amount  of  circulating  notes  has 
been  issued  less  than  the  par  value  of  the  bonds,  shall  be  entitled, 
upon  due  application  to  the  Comptroller  of  the  Currency,  to 
receive  additional  circulating  notes  in  blank  to  an  amount  which 
will  increase  the  circulating  notes  held  by  such  association  to 
the  par  value  of  the  bonds  deposited,  such  additional  notes  to 
be  held  and  treated  in  the  same  way  as  circulating  notes  of 
national  banking  associations  heretofore  issued,  and  subject  to 
all  the  provisions  of  law  affecting  such  notes:  Provided,  That 
nothing  herein  contained  shall  be  construed  to  modify  or  repeal 
the  provisions  of  section  fifty-one  hundred  and  sixty-seven  of 
the  Revised  Statutes  of  the  United  States,  authorizing  the 
Comptroller  of  the  Currency  to  require  additional  deposits  of 
bonds  or  of  lawful  money  in  case  the  market  value  of  the  bonds 
held  to  secure  the  circulating  notes  shall  fall  below  the  par 
value  of  the  circulating  notes  outstanding  for  which  such  bonds 
may  be  deposited  as  security :  And  provided  further,  That  the 
circulating  notes  furnished  to  national  banking  associations 
under  the  provisions  of  this  Act  shall  be  of  the  denominations 
prescribed  by  law,  except  that  no  national  banking  association 
shall,  after  the  passage  of  this  Act,  be  entitled  to  receive  from 
the  Comptroller  of  the  Currency,  or  to  issue  or  reissue  or  place 
in  circulation,  more  than  one-third  in  amount  of  its  circulating 


472  APPENDIX 

notes  of  the  denomination  of  five  dollars:  And  provided  fur- 
ther,  That  the  total  amount  of  such  notes  issued  to  any  such 
association  may  equal  at  any  time  but  shall  not  exceed  the 
amount  at  such  time  of  its  capital  stock  actually  paid  in: 
And  provided  further,  That  under  regulations  to  be  prescribed 
by  the  Secretary  of  the  Treasury  any  national  banking  associa- 
tion may  substitute  the  two  per  centum  bonds  issued  under  the 
provisions  of  this  Act  for  any  of  the  bonds  deposited  with  the 
Treasurer  to  secure  circulation  or  to  secure  deposits  of  public 
money;  and  so  much  of  an  Act  entitled  "An  Act  to  enable 
national  banking  associations  to  extend  their  corporate  existence, 
and  for  other  purposes,"  approved  July  twelfth,  eighteen 
hundred  and  eighty-two,  as  prohibits  any  national  bank  which 
makes  any  deposit  of  lawful  money  in  order  to  withdraw  its 
circulating  notes  from  re2eiving  any  increase  of  its  circulation 
for  the  period  of  six  months  from  the  time  it  made  such  deposit 
of  lawful  money  for  the  purpose  aforesaid,  is  hereby  repealed, 
and  all  other  Acts  or  parts  of  Acts  inconsistent  with  the  pro- 
visions of  this  section  are  hereby  repealed. 

SEC.  13.  That  every  national  banking  association  having  on 
deposit,  as  provided  by  law,  bonds  of  the  United  States  bearing 
interest  at  the  rate  of  two  per  centum  per  annum,  issued  under 
the  provisions  of  this  Act,  to  secure  its  circulating  notes,  shall 
pay  to  the  Treasurer  of  the  United  States,  in  the  months  of 
January  and  July,  a  tax  of  one-fourth  of  one  per  centum  each 
half  year  upon  the  average  amount  of  such  of  its  notes  in 
circulation  as  are  based  upon  the  deposit  of  said  two  per  centum 
bonds ;  and  such  taxes  shall  be  in  lieu  of  existing  taxes  on  its 
notes  in  circulation  imposed  by  section  fifty-two  hundred  and 
fourteen  of  the  Revised  Statutes. 

SEC.  14.  That  the  provisions  of  this  Act  are  not  intended  to 
preclude  the  accomplishment  of  international  bimetallism  when- 
ever conditions  shall  make  it  expedient  and  practicable  to  secure 
the  same  by  concurrent  action  of  the  leading  commercial  nations 
of  the  world  and  at  a  ratio  which  shall  insure  permanence  of 
relative  value  between  gold  and  silver. 

Approved,  March  14,  1900. 


APPENDIX  II 

ALDRICH-VREELAND    ACT    OF    1908 

[PUBLIC— No.  169.] 
An  Act  To  amend  the  national  banking  laws. 

Be  it  enacted  by  the  Senate  and  House  of  Representatives 
of  the  United  States  of  America  in  Congress  assembled,  That 
national  banking  associations,  each  having  an  unimpaired 
capital  and  surplus  of  not  less  than  twenty  per  centum,  not 
less  than  ten  in  number,  having  an  aggregate  capital  and  sur- 
plus of  at  least  five  millions  of  dollars,  may  form  voluntary 
associations  to  be  designated  as  national  currency  associations. 
The  banks  uniting  to  form  such  association  'shall,  by  their 
presidents  or  vice-presidents,  acting  under  authority  from  the 
board  of  directors,  make  and  file  with  the  Secretary  of  the 
Treasury  a  certificate  setting  forth  the  names  of  the  banks 
composing  the  association,  the  principal  place  of  business  of 
the  association,  and  the  name  of  the  association,  which  name 
shall  be  subject  to  the  approval  of  the  Secretary  of  the 
Treasury.  Upon  the  filing  of  such  certificate  the  associated 
banks  therein  named  shall  become  a  body  corporate,  and  by  the 
name  so  designated  and  approved  may  sue  and  be  sued  and 
exercise  the  powers  of  a  body  corporate  for  the  purposes  here- 
inafter mentioned:  Provided,  That  not  more  than  one  such 
national  currency  association  shall  be  formed  in  any  city: 
Provided  further,  That  the  several  members  of  such  national 
currency  association  shall  be  taken,  as  nearly  as  conveniently 
may  be,  from  a  territory  composed  of  a  State  or  part  of  a 
State,  or  contiguous  parts  of  one  or  more  States:  And  pro- 
vided further,  That  any  national  bank  in  such  city  or  territory, 

473 


474.  APPENDIX 

having  the  qualifications  herein  prescribed  for  membership  in 
such  national  currency  association,  shall,  upon  its  application 
to  and  upon  the  approval  of  the  Secretary  of  the  Treasury, 
be  admitted  to  membership  in  a  national  currency  association 
for  that  city  or  territory,  and  upon  such  admission  shall  be 
deemed  and  held  a  part  of  the  body  corporate,  and  as  such 
entitled  to  all  the  rights  and  privileges  and  subject  to  all  the 
liabilities  of  an  original  member:  And  provided  further,  That 
each  national  currency  association  shall  be  composed  exclusively 
of  banks  not  members  of  any  other  national  currency  associa- 
tion. 

The  dissolution,  voluntary  or  otherwise,  of  any  bank  in  such 
association  shall  not  affect  the  corporate  existence  of  the  asso- 
ciation unless  there  shall  then  remain  less  than  the  minimum 
number  of  ten  banks:  Provided,  however,  That  the  reduction 
of  the  number  of  said  banks  below  the  minimum  of  ten  shall 
not  affect  the  existence  of  the  corporation  with  respect  to  the 
assertion  of  all  rights  in  favor  of  or  against  such  association. 
The  affairs  of  the  association  shall  be  managed  by  a  board 
consisting  of  one  representative  from  each  bank.  By-laws  for 
the  government  of  the  association  shall  be  made  by  the  board, 
subject  to  the  approval  of  the  Secretary  of  the  Treasury.  A 
president,  vice-president,  secretary,  treasurer,  and  executive 
committee  of  not  less  than  five  members,  shall  be  elected  by 
the  board.  The  powers  of  such  board,  except  in  the  election 
of  officers  and  making  of  by-laws,  may  be  exercised  through 
its  executive  committee. 

The  national  currency  association  herein  provided  for  shall 
have  and  exercise  any  and  all  powers  necessary  to  carry  out 
the  purposes  of  this  section,  namely,  to  render  available,  under 
the  direction  and  control  of  the  Secretary  of  the  Treasury, 
as  a  basis  for  additional  circulation  any  securities,  including 
commercial  paper,  held  by  a  national  banking  association.  For 
the  purpose  of  obtaining  such  additional  circulation,  any  bank 
belonging  to  any  national  currency  association,  having  circu- 
lating notes  outstanding  secured  by  the  deposit  of  bonds  of 
the  United  States  to  an  amount  not  less  than  forty  per  centum 


APPENDIX  4,75 

of  its  capital  stock,  and  which  has  its  capital  unimpaired  and 
a  surplus  of  not  less  than  twenty  per  centum,  may   deposit 
with  and  transfer  to  the  association,  in  trust  for  the  United 
States,  for  the  purpose  hereinafter  provided,  such  of  the  securi- 
ties above  mentioned  as  may  be  satisfactory  to  the  board  of 
the  association.     The  officers  of  the  association  may  thereupon, 
in  behalf  of  such  bank,  make  application  to  the  Comptroller 
of  the  Currency  for  an  issue  of  additional  circulating  notes  to 
an  amount  not  exceeding  seventy-five  per  centum  of  the  cash 
value  of  the  securities  or  commercial  paper  so  deposited.     The 
Comptroller  of  the  Currency  shall  immediately  transmit  such 
application  to  the  Secretary  of  the  Treasury  with  such  recom- 
mendation as  he  thinks  proper,  and  if,  in  the  judgment  of 
the  Secretary  of  the  Treasury,  business  conditions  in  the  local- 
ity demand  additional  circulation,  and  if  he  be  satisfied  with 
the  character  and  value  of  the  securities  proposed  and  that  a 
lien  in  favor  of  the  United  States  on  the  securities  so  deposited 
and  on  the  assets  of  the  banks  composing  the  association  will 
be  amply  sufficient  for  the  protection   of  the  United   States, 
he  may  direct  an  issue  of  additional  circulating  notes  to  the 
association,  on  behalf  of  such  bank,  to  an  amount  in  his  dis- 
cretion, not,  however,  exceeding  seventy-five  per  centum  of  the 
cash  value  of  the  securities  so  deposited:     Provided,  That  upon 
the  deposit  of  any  of  the  State,  city,  town,  county,  or  other 
municipal  bonds,  of  a  character  described  in  section  three  of 
this  Act,  circulating  notes  may  be  issued  to  the  extent  of  not 
exceeding  ninety  per  centum  of  the  market  value  of  such  bonds 
so  deposited:     And  provided  further,  That  no  national  bank- 
ing association  shall  be  authorized  in  any  event  to  issue  circulat- 
ing notes  based  on  commercial  paper  in  excess  of  thirty  per 
centum  of  its  unimpaired  capital  and  surplus.     The  term  "com- 
mercial paper"  shall  be  held  to  include  only  notes  representing 
actual   commercial  transactions,   which  when   accepted  by  the 
association  shall  bear  the  names  of  at  least  two  responsible  par- 
ties and  have  not  exceeding  four  months  to  run. 

The  banks  and  the  assets  of  all  banks  belonging  to  the  asso- 
ciation shall  be  jointly  and  severally  liable  to  the  United  States 


476  APPENDIX 

for  the  redemption  of  such  additional  circulation;  and  to 
secure  such  liability  the  lien  created  by  section  fifty-two  hun- 
dred and  thirty  of  the  Revised  Statutes  shall  extend  to  and 
cover  the  assets  of  all  banks  belonging  to  the  association,  and 
to  the  securities  deposited  by  the  banks  with  the  association 
pursuant  to  the  provisions  of  this  Act;  but  as  between  the 
several  banks  composing  such  association  each  bank  shall  be 
liable  only  in  the  proportion  that  its  capital  and  surplus  bears 
to  the  aggregate  capital  and  surplus  of  all  such  banks.  The 
association  may,  at  any  time,  require  of  any  of  its  constituent 
banks  a  deposit  of  additional  securities  or  commercial  paper, 
or  an  exchange  of  the  securities  already  on  deposit,  to  secure 
such  additional  circulation ;  and  in  case  of  the  failure  of  such 
bank  to  make  such  deposit  or  exchange  the  association  may, 
after  ten  days'  notice  to  the  bank,  sell  the  securities  and  paper 
already  in  its  hands  at  public  sale,  and  deposit  the  proceeds  with 
the  Treasurer  of  the  United  States  as  a  fund  for  the  redemp- 
tion of  such  additional  circulation.  If  such  fund  be  insuffi- 
cient for  that  purpose  the  association  may  recover  from  the 
bank  the  amount  of  the  deficiency  by  suit  in  the  circuit  court 
of  the  United  States,  and  shall  have  the  benefit  of  the  lien 
hereinbefore  provided  for  in  favor  of  the  United  States  upon  the 
assets  of  such  bank.  The  association  or  the  Secretary  of  the 
Treasury  may  permit  or  require  the  withdrawal  of  any  such 
securities  or  commercial  paper  and  the  substitution  of  other 
securities  or  commercial  paper  of  equal  value  therefor. 

SEC.  2.  That  whenever  any  bank  belonging  to  a  national 
currency  association  shall  fail  to  preserve  or  make  good  its 
redemption  fund  in  the  Treasury  of  the  United  States,  required 
by  section  three  of  the  Act  of  June  twentieth,  eighteen  hundred 
and  seventy-four,  chapter  three  hundred  and  forty  three,  and 
the  provisions  of  this  Act,  the  Treasurer  of  the  United  States 
shall  notify  such  national  currency  association  to  make  good 
such  redemption  fund,  and  upon  the  failure  of  such  national 
currency  association  to  make  good  such  fund,  the  Treasurer 
of  the  United  States  may,  in  his  discretion,  apply  so  much  of 
the  redemption  fund  belonging  to  the  other  banks  composing 


APPENDIX  477 

such  national  currency  association  as  may  be  necessary  for  that 
purpose;  and  such  national  currency  association  may,  after 
five  days'  notice  to  such  bank,  proceed  to  sell  at  public  sale 
the  securities  deposited  by  such  bank  with  the  association  pur- 
suant to  the  provisions  of  section  one  of  this  Act,  and  deposit 
the  proceeds  with  the  Treasurer  of  the  United  States  as  a  fund 
for  the  redemption  of  the  additional  circulation  taken  out  by 
such  bank  under  this  Act. 

SEC.  3.  That  any  national  banking  association  which  has 
circulating  notes  outstanding,  secured  by  the  deposit  of 
United  States  bonds  to  an  amount  of  not  less  than  forty  per 
centum  of  its  capital  stock,  and  which  has  a  surplus  of  not 
less  than  twenty  per  centum,  may  make  application  to  the 
Comptroller  of  the  Currency  for  authority  to  issue  additional 
circulating  notes  to  be  secured  by  the  deposit  of  bonds  other 
than  bonds  of  the  United  States.  The  Comptroller  of  the  Cur- 
rency shall  transmit  immediately  the  application,  with  his 
recommendation,  to  the  Secretary  of  the  Treasury,  who  shall, 
if  in  his  judgment  business  conditions  in  the  locality  demand 
additional  circulation,  approve  the  same,  and  shall  determine 
the  time  of  issue  and  fix  the  amount,  within  the  limitations 
herein  imposed,  of  the  additional  circulating  notes  to  be  issued. 
Whenever  after  receiving  notice  of  such  approval  any  such 
association  shall  deposit  with  the  Treasurer  or  any  assistant 
treasurer  of  the  United  States  such  of  the  bonds  described  in  this 
section  as  shall  be  approved  in  character  and  amount  by  the 
Treasurer  of  the  United  States  and  the  Secretary  of  the  Treas- 
ury, it  shall  be  entitled  to  receive,  upon  the  order  of  the  Comp- 
troller of  the  Currency,  circulating  notes  in  blank,  registered 
and  countersigned  as  provided  by  law,  not  exceeding  in  amount 
ninety  per  centum  of  the  market  value,  but  not  in  excess  of 
the  par  value  of  any  bonds  so  deposited,  such  market  value  to 
be  ascertained  and  determined  under  the  direction  of  the  Secre- 
tary of  the  Treasury. 

The  Treasurer  of  the  United  States,  with  the  approval  of  the 
Secretary  of  the  Treasury,  shall  accept  as  security  for  the 
additional  circulating  notes  provided  for  in  this  section,  bonds 


478  APPENDIX 

or  other  interest-bearing  obligations  of  any  State  of  the  United 
States,  or  any  legally  authorized  bonds  issued  by  any  city, 
town,  county,  or  other  legally  constituted  municipality  or  dis- 
trict in  the  United  States  which  has  been  in  existence  for  a 
period  of  ten  years,  and  which  for  a  period  of  ten  years  previous 
to  such  deposit  has  not  defaulted  in  the  payment  of  any  part 
of  either  principal  or  interest  of  any  funded  debt  authorized 
to  be  contracted  by  it,  and  whose  net  funded  indebtedness  does 
not  exceed  ten  per  centum  of  the  valuation  of  its  taxable 
property,  to  be  ascertained  by  the  last  preceding  valuation  of 
property  for  the  assessment  of  taxes.  The  Treasurer  of  the 
United  States,  with  the  approval  of  the  Secretary  of  the  Treas- 
ury, shall  accept,  for  the  purposes  of  this  section,  securities 
herein  enumerated  in  such  proportions  as  he  may  from  time 
to  time  determine,  and  he  may  with  such  approval  at  any  time 
require  the  deposit  of  additional  securities,  or  require  any  asso- 
ciation to  change  the  character  of  the  securities  already  on 
deposit. 

SEC.  4.  That  the  legal  title  of  all  bonds,  whether  coupon 
or  registered,  deposited  to  secure  circulating  notes  issued  in 
accordance  with  the  terms  of  section  three  of  this  Act  shall  be 
transferred  to  the  Treasurer  of  the  United  States  in  trust  for 
the  association  depositing  them,  under  regulations  to  be  pre- 
scribed by  the  Secretary  of  the  Treasury.  A  receipt  shall  be 
given  to  the  association  by  the  Treasurer  or  any  assistant  treas- 
urer of  the  United  States,  stating  that  such  bond  is  held  in  trust 
for  the  association  on  whose  behalf  the  transfer  is  made,  and 
as  security  for  the  redemption  and  payment  of  any  circulating 
notes  that  have  been  or  may  be  delivered  to  such  association. 
No  assignment  or  transfer  of  any  such  bond  by  the  Treasurer 
shall  be  deemed  valid  unless  countersigned  by  the  Comptroller 
of  the  Currency.  The  provisions  of  sections  fifty-one  hundred 
and  sixty-three,  fifty-one  hundred  and  sixty-four,  fifty-one 
hundred  and  sixty-five,  fifty-one  hundred  and  sixty-six,  and 
fifty-one  hundred  and  sixty-seven  and  sections  fifty-two  hundred 
and  twenty-four  to  fifty-two  hundred  and  thirty-four,  inclu- 
sive, of  the  Revised  Statutes  respecting  United  States  bonds 


APPENDIX  479 

deposited  to  secure  circulating  notes  shall,  except  as  herein 
modified,  be  applicable  to  all  bonds  deposited  under  the  terms 
of  section  three  of  this  Act. 

SEC.  5.  That  the  additional  circulating  notes  issued  under 
this  Act  shall  be  used,  held,  and  treated  in  the  same  way  as  cir- 
culating notes  of  national  banking  associations  heretofore  issued 
and  secured  by  a  deposit  of  United  States  bonds,  and  shall  be 
subject  to  all  the  provisions  of  law  affecting  such  notes  except 
as  herein  expressly  modified:  Provided,  That  the  total  amount 
of  circulating  notes  outstanding  of  any  national  banking  asso- 
ciation, including  notes  secured  by  United  States  bonds  as  now 
provided  by  law,  and  notes  secured  otherwise  than  by  deposit 
of  such  bonds,  shall  not  at  any  time  exceed  the  amount  of  its 
unimpaired  capital  and  surplus:  And  provided  further.  That 
there  shall  not  be  outstanding  at  any  time  circulating  notes 
issued  under  the  provisions  of  this  Act  to  an  amount  of  more 
than  five  hundred  millions  of  dollars. 

SEC.  6.  That  whenever  and  so  long  as  any  national  banking 
association  has  outstanding  any  of  the  additional  circulating 
notes  authorized  to  be  issued  by  the  provisions  of  this  Act  it 
shall  keep  on  deposit  in  the  Treasury  of  the  United  States,  in 
addition  to  the  redemption  fund  required  by  section  three  of  the 
Act  of  June  twentieth,  eighteen  hundred  and  seventy-four,  an 
additional  sum  equal  to  five  per  centum  of  such  additional  cir- 
culation at  any  time  outstanding,  such  additional  five  per  centum 
to  be  treated,  held,  and  used  in  all  respects  in  the  same  manner 
as  the  original  redemption  fund  provided  for  by  said  section 
three  of  the  Act  of  June  twentieth,  eighteen  hundred  and 
seventy-four. 

SEC.  7-  In  order  that  the  distribution  of  notes  to  be  issued 
under  the  provisions  of  this  Act  shall  be  made  as  equitable  as 
practicable  between  the  various  sections  of  the  country,  the 
Secretary  of  the  Treasury  shall  not  approve  applications  from 
associations  in  any  State  in  excess  of  the  amount  to  which  such 
State  would  be  entitled  of  the  additional  notes  herein  authorized 
on  the  basis  of  the  proportion  which  the  unimpaired  capital  and 
surplus  of  the  national  banking  associations  in  such  State  bears 


480  APPENDIX 

to  the  total  amount  of  unimpaired  capital  and  surplus  of  tne 
national  banking  associations  of  the  United  States:  Provided, 
however,  That  in  case  the  applications  from  associations  in  any 
State  shall  not  be  equal  to  the  amount  which  the  associations 
of  such  State  would  be  entitled  to  under  this  method  of  dis- 
tribution, the  Secretary  of  the  Treasury  may,  in  his  discretion, 
to  meet  an  emergency,  assign  the  amount  not  thus  applied  for  to 
any  applying  association  or  associations  in  States  in  the  same 
section  of  the  country. 

SEC.  8.  That  it  shall  be  the  duty  of  the  Secretary  of  the 
Treasury  to  obtain  information  with  reference  to  the  value  and 
character  of  the  securities  authorized  to  be  accepted  under  the 
provisions  of  this  Act,  and  he  shall  from  time  to  time  furnish 
information  to  national  banking  associations  as  to  such  se- 
curities as  would  be  acceptable  under  the  provisions  of  this  Act. 

SEC.  9.  That  section  fifty-two  hundred  and  fourteen  of  the 
Revised  Statutes,  as  amended,  be  further  amended  to  read  as 
follows : 

"SEC.  5214.  National  banking  associations  having  on  de- 
posit bonds  of  the  United  States,  bearing  interest  at  the  rate 
of  two  per  centum  per  annum,  including  the  bonds  issued  for 
the  construction  of  the  Panama  Canal,  under  the  provisions  of 
section  eight  of  'An  Act  to  provide  for  the  construction  of  a 
canal  connecting  the  waters  of  the  Atlantic  and  Pacific  oceans,' 
approved  June  twenty-eight,  nineteen  hundred  and  two,  to 
secure  its  circulating  notes,  shall  pay  to  the  Treasurer  of  the 
United  States,  in  the  months  of  January  and  July,  a  tax  of 
one-fourth  of  one  per  centum  each  half  year  upon  the  average 
amount  of  such  of  its  notes  in  circulation  as  are  based  upon 
the  deposit  of  such  bonds;  and  such  associations  having  on 
deposit  bonds  of  the  United  States  bearing  interest  at  a  rate 
higher  than  two  per  centum  per  annum  shall  pay  a  tax  of  one- 
half  of  one  per  centum  each  half  year  upon  the  average  amount 
of  such  of  its  notes  in  circulation  as  are  based  upon  the  deposit 
of  such  bonds.  National  banking  associations  having  circulat- 
ing notes  secured  otherwise  than  by  bonds  of  the  United  States 
shall  pay  for  the  first  month  a  tax  at  the  rate  of  five  per  centum 


APPENDIX  481 

per  annum  upon  the  average  amount  of  such  of  their  notes  in 
circulation  as  are  based  upon  the  deposit  of  such  securities, 
and  afterwards  an  additional  tax  of  one  per  centum  per  annum 
for  each  month  until  a  tax  of  ten  per  centum  per  annum  is 
reached,  and  thereafter  such  tax  of  ten  per  centum  per  annum, 
upon  the  average  amount  of  such  notes.  Every  national  bank- 
ing association  having  outstanding  circulating  notes  secured 
by  a  deposit  of  other  securities  than  United  States  bonds  shall 
make  monthly  returns,  under  oath  of  its  president  or  cashier, 
to  the  Treasurer  of  the  United  States,  in  such  form  as  the 
Treasurer  may  prescribe,  of  the  average  monthly  amount  of 
its  notes  so  secured  in  circulation ;  and  it  shall  be  the  duty  of  the 
Comptroller  of  the  Currency  to  cause  such  reports  of  notes  in 
circulation  to  be  verified  by  examination  of  the  banks'  records. 
The  taxes  received  on  circulating  notes  secured  otherwise  than 
by  bonds  of  the  United  States  shall  be  paid  into  the  Division 
of  Redemption  of  the  Treasury  and  credited  and  added  to  the 
reserve  fund  held  for  the  redemption  of  United  States  and  other 
notes." 

SEC.  10.  That  section  nine  of  the  Act  approved  July 
twelfth,  eighteen  hundred  and  eighty-two,  as  amended  by  the 
Act  approved  March  fourth,  nineteen  hundred  and  seven,  be 
further  amended  to  read  as  follows: 

"SEC.  9.  That  any  national  banking  association  desiring 
to  withdraw  its  circulating  notes,  secured  by  deposit  of  United 
States  bonds  in  the  manner  provided  in  section  four  of  the  Act 
approved  June  twentieth,  eighteen  hundred  and  seventy-four,  is 
hereby  authorized  for  that  purpose  to  deposit  lawful  money  with 
the  Treasurer  of  the  United  States  and,  with  the  consent  of  the 
Comptroller  of  the  Currency  and  the  approval  of  the  Secretary 
of  the  Treasury,  to  withdraw  a  proportionate  amount  of  bonds 
held  as  security  for  its  circulating  notes  in  the  order  of  such 
deposits:  Provided,  That  not  more  than  nine  millions  of 
dollars  of  lawful  money  shall  be  so  deposited  during  any  calendar 
month  for  this  purpose. 

"Any  national  banking  association  desiring  to  withdraw  any 
of  its  circulating  notes,  secured  by  the  deposit  of  securities  other 
VII— 31  . 


482  APPENDIX 

than  bonds  of  the  United  States,  may  make  such  withdrawal  at 
any  time  in  like  manner  and  effect  by  the  deposit  of  lawful  money 
or  national  bank  notes  with  the  Treasurer  of  the  United  States, 
and  upon  such  deposit  a  proportionate  share  of  the  securities  so 
deposited  may  be  withdrawn:  Provided,  That  the  deposits 
under  this  section  to  retire  notes  secured  by  the  deposit  of  securi- 
ties other  than  bonds  of  the  United  States  shall  not  be  covered 
into  the  Treasury,  as  required  by  section  six  of  an  Act  entitled 
'An  Act  directing  the  purchase  of  silver  bullion  and  the  issue 
of  Treasury  notes  thereon,  and  for  other  purposes,'  approved 
July  fourteenth,  eighteen  hundred  and  ninety,  but  shall  be  re- 
tained in  the  Treasury  for  the  purpose  of  redeeming  the  notes 
of  the  bank  making  such  deposit." 

SEC.  11.  That  section  fifty-one  hundred  and  seventy-two  of 
the  Revised  Statutes  be,  and  the  same  is  hereby,  amended  to  read 
as  follows: 

"SEC.  5172.  In  order  to  furnish  suitable  notes  for  circulation, 
the  Comptroller  of  the  Currency  shall,  under  the  direction  of 
the  Secretary  of  the  Treasury,  cause  plates  and  dies  to  be  en- 
graved, in  the  best  manner  to  guard  against  counterfeiting  and 
fraudulent  alterations,  and  shall  have  printed  therefrom,  and 
numbered,  such  quantity  of  circulating  notes,  in  blank,  of  the 
denominations  of  five  dollars,  ten  dollars,  twenty  dollars,  fifty 
dollars,  one  hundred  dollars,  five  hundred  dollars,  one  thousand 
dollars,  and  ten  thousand  dollars,  as  may  be  required  to  supply 
the  associations  entitled  to  receive  the  same.  Such  notes  shall 
state  upon  their  face  that  they  are  secured  by  United  States 
bonds  or  other  securities,  certified  by  the  written  or  engraved 
signatures  of  the  Treasurer  and  Register  and  by  the  imprint  of 
the  seal  of  the  Treasury.  They  shall  also  express  upon  their 
face  the  promise  of  the  association  receiving  the  same  to  pay  on 
demand,  attested  by  the  signature  of  the  president  or  vice-presi- 
dent and  cashier.  The  Comptroller  of  the  Currency,  acting 
under  the  direction  of  the  Secretary  of  the  Treasury,  shall  as 
soon  as  practicable  cause  to  be  prepared  circulating  notes  in 
blank,  registered  and  countersigned,  as  provided  by  law,  to  an 
amount  equal  to  fifty  per  centum  of  the  capital  stock  of  each 


APPENDIX  483 

national  banking  association;  such  notes  to  be  deposited  in  the 
Treasury  or  in  the  subtreasury  of  the  United  States  nearest  the 
place  of  business  of  each  association,  and  to  be  held  for  such 
association,  subject  to  the  order  of  the  Comptroller  of  the 
Currency,  for  their  delivery  as  provided  by  law:  Provided, 
That  the  Comptroller  of  the  Currency  may  issue  national  bank 
notes  of  the  present  form  until  plates  can  be  prepared  and  circu- 
lating notes  issued  as  above  provided :  Provided,  however,  That 
in  no  event  shall  bank  notes  of  the  present  form  be  issued  to  any 
bank  as  additional  circulation  provided  for  by  this  Act." 

SEC.  12.  That  circulating  notes  of  national  banking  associa- 
tions, when  presented  to  the  Treasury  for  redemption,  as 
provided  in  section  three  of  the  Act  approved  June  twentieth, 
eighteen  hundred,  and  seventy-four,  shall  be  redeemed  in  lawful 
money  of  the  United  States. 

SEC.  13.  That  all  acts  and  orders  of  the  Comptroller  of  the 
Currency  and  the  Treasurer  of  the  United  States  authorized  by 
this  Act  shall  have  the  approval  of  the  Secretary  of  the  Treasury 
who  shall  have  power,  also,  to  make  any  such  rules  and  regula- 
tions and  exercise  such  control  over  the  organization  and 
management  of  national  currency  associations  as  may  be  neces- 
sary to  carry  out  the  purposes  of  this  Act. 

SEC.  14.  That  the  provisions  of  section  fifty-one  hundred  and 
ninety-one  of  the  Revised  Statutes,  with  reference  to  the  reserves 
of  national  banking  associations,  shall  not  apply  to  deposits  of 
public  moneys  by  the  United  States  in  designated  depositaries. 

SEC.  15.  That  all  national  banking  associations  designated 
as  regular  depositaries  of  public  money  shall  pay  upon  all  special 
and  additional  deposits  made  by  the  Secretary  of  the  Treasury 
in  such  depositaries,  and  all  such  associations  designated  as  tem- 
porary depositaries  of  public  money  shall  pay  upon  all  sums  of 
public  money  deposited  in  such  associations  interest  at  such  rate 
as  the  Secretary  of  the  Treasury  may  prescribe,  not  less,  how- 
ever, than  one  per  centum  per  annum  upon  the  average  monthly 
amount  of  such  deposits :  Provided,  however,  That  nothing  con- 
tained in  this  Act  shall  be  construed  to  change  or  modify  the 
obligation  of  any  association  or  any  of  its  officers  for  the  safe- 


484.  APPENDIX 

keeping  of  public  money :  Provided,  further,  that  the  rate  of 
interest  charged  upon  such  deposits  shall  be  equal  and  uniform 
throughout  the  United  States. 

SEC.  16.  That  a  sum  sufficient  to  carry  out  the  purposes  of 
the  preceding  sections  of  this  Act  is  hereby  appropriated  out 
of  any  money  in  the  Treasury  not  otherwise  appropriated. 

SEC.  17.  That  a  Commission  is  hereby  created,  to  be  called 
the  "National  Monetary  Commission,"  to  be  composed  of  nine 
members  of  the  Senate,  to  be  appointed  by  the  Presiding  Officer 
thereof,  and  nine  members  of  the  House  of  Representatives,  to 
be  appointed  by  the  Speaker  thereof;  and  any  vacancy  on  the 
Commission  shall  be  filled  in  the  same  manner  as  the  original 
appointment. 

SEC.  18.  That  it  shall  be  the  duty  of  this  Commission  to 
inquire  into  and  report  to  Congress  at  the  earliest  date  prac- 
ticable, what  changes  are  necessary  or  desirable  in  the  monetary 
system  of  the  United  States  or  in  the  laws  relating  to  banking 
and  currency,  and  for  this  purpose  they  are  authorized  to  sit 
during  the  sessions  or  recess  of  Congress,  at  such  times  and 
places  as  they  may  deem  desirable,  to  send  for  persons  and 
papers,  to  administer  oaths,  to  summons  and  compel  the  attend- 
ance of  witnesses,  and  to  employ  a  disbursing  officer  and  such 
secretaries,  experts,  stenographers,  messengers,  and  other  assist- 
ants as  shall  be  necessary  to  carry  out  the  purposes  for  which 
said  Commission  was  created.  The  Commission  shall  have  the 
power,  through  subcommittee  or  otherwise,  to  examine  witnesses 
and  to  make  such  investigations  and  examinations,  in  this  or 
other  countries,  of  the  subjects  committed  to  their  charge  as 
they  shall  deem  necessary. 

SEC.  19.  That  a  sum  sufficient  to  carry  out  the  purposes  of 
sections  seventeen  and  eighteen  of  this  Act,  and  to  pay  the 
necessary  expenses  of  the  Commission  and  its  members,  is  hereby 
appropriated,  out  of  any  money  in  the  Treasury  not  otherwise 
appropriated.  Said  appropriation  shall  be  immediately  avail- 
able and  shall  be  paid  out  on  the  audit  and  order  of  the  chairman 
or  acting  chairman  of  said  Commission,  which  audit  and  order 


APPENDIX  485 

shall  be  conclusive  and  binding  upon  all  Departments  as  to  the 
correctness  of  the  accounts  of  such  Commission. 

SEC.  20.  That  this  Act  shall  expire  by  limitation  on  the 
thirtieth  day  of  June,  nineteen  hundred  and  fourteen. 

Approved,  May  30,  1908. 


INDEX 


Acceptability,  a  requisite  of  money, 

41. 
Act, 

Aldrich-Vreeland,  259. 
Legal  tender,  61. 
National     Bank     (see     National 

Bank  Act),  365. 
Of  1900,  62. 

Of  1844  (England),  398. 
Sherman,  172. 
Agencies,  credit,  339. 
Agricultural  products  as  money,  38. 
Aldrich-Vreeland  Act,  259. 
Arbitrage,  151-152. 
Assets,  concealed,  264. 


B 

Bank  (or  Banks), 
Attitude  toward  silver,  175. 
Capital  and  credit,  243. 
Capital  stock  of,  271. 
Cashier,  293. 
Classified,  280-282. 
Commercial,  387,  427. 
Credit,  department  of,  337-346. 
Difficulties  of  establishing,  306. 
Directors  of,  287-293. 
Discount  clerk,  296. 
Early,  348-349. 
Earning  power  of,  253. 
Economic  functions  of,  231-247. 
Employes  of,  294-297. 
Evolution  of,  286. 
Financial,  388-427. 
First  United  States,  350. 
Foreign  Department  of,  143. 

487 


Functions    in    making    payment, 

113-114. 

Liability  of  in  collecting,  299. 
Liability  of  stockholders,  272. 
Loans  (see  Loans). 
Note  teller,  295. 
Officers  of,  293-294. 
Operation  of,  244. 
Organization  of,  286. 
Paying  teller,  294. 
Private,  280. 

Savings  (see  Savings  Banks). 
Second  United  States,  353. 
Settlement   of   accounts    between, 

116. 

Stockholders  of,  286. 
U.  S.  Treasury  in  relation  to,  390- 

394. 

Wall  Street's  relation  to,  381-389. 
Bank  Act  of  1844,  398. 
Bank  circulation,  expansion  of,  376. 
Bank  Credit, 
Advantages  of,  251-253. 
Deposit,  203-208. 
Bankers, 

Privileges  of,  239-241. 
Requisite  qualities,  315. 
Responsibility  of,  245-247. 
Banking, 

Branch  (In  Canada),  412-413. 
Commercial,  195  (see  Commercial 

banking). 

Early  characteristics,  347. 
English  customs,  139. 
France,  401-402. 
Institution  in  production  of  wealth, 

10. 

Historical  periods,  348. 
State,  356. 


488 


INDEX 


Banking  Systems, 

Canadian,  409-418. 

(See  Canadian  Banking  System.) 

European,  395-408. 

National,  365-370. 

State  experiments  with,  362-364. 
Bank  of  England, 

Act  of  1844,  398. 

Character  of  note,  399. 

Control  over  gold  supply,  129. 

History,  395-399. 

Management  of,  400. 

Origin,  395. 

Relation  to  Government,  397. 
Bank  of  France,  130. 

Branches  of,  404-406. 

Currency  of,  403. 

System  of,  404-406. 
Bank  of  Germany, 

Government  relation  to,  406. 

System  of,  407. 
Bank  notes,  prices  affected  by,  213- 

215. 

Bank  reserve,  207. 
Bank  reserves,  78. 
Bank  Statement, 

Combined,  260. 

Double  entry  system  in,  262-265. 

Liabilities  in,  271-279. 

Resources  in,  260-270. 

Surplus  fund  in,  273-275. 

United  States  bonds  in,  266. 
Bank  System, 

Bond  Deposit,  359. 

Free,  361-364. 

New  York,  359. 

Safety  fund,  359. 

Suffolk,  357-358. 
Barter, 

Exchange  by,  12. 

Influence  on  industry,  12. 
Beaver  skins  as  money,  37. 
Belmont-Morgan  Syndicate,  180. 
Bimetallism,  30. 

Advantages  of,  165. 

Defined,  164. 

Difficulties  of,  164. 


Disadvantages  to  commerce,  166. 

International,  166. 
Bonds, 

Defined,  196. 

Interest  rates  on,  198. 

Issues  in  early  90's,  179-180. 

Timber,  198. 

Borrowing,  long  time,  199. 
Branch  Banking,  424. 

Canadian,  412. 
Briggs  vs.  Spalding,  290. 
Business, 

Beginning  of,  5. 

Practice  of,  4. 

Result  of  division  of  labor,  5. 

Technology  of,  4. 


Cables,  Foreign  Exchange,  136. 

Call  Loan  Rates,  384. 

Call  Loans,  326. 

Canadian  Banking  System,  409-418. 

Canadian  Banking  System, 

Branch  banking  in,  412. 

Government  relation  to,  409. 

Grain  as  security  in,  415. 

Note  circulation  in,  416-418. 

Note  issues  of,  409. 

Operation  of,  413. 

Redemption  fund  of,  410. 

Reserves  of,  411. 
Capital, 

Bank,  243  (see  Bank). 

Bank  a  distributor  of,  236. 

Defined,  20. 

Economic  importance  of,  20. 

Fixed,  428. 

Movements  of,  133. 

Relation  to  currency,  22. 

Temporary  providing  of,  327. 

Value  proportionate  to  income,  20. 

Working  (defined),  428. 

Working  (of  dealers  in  securities), 
382. 


INDEX 


489 


Capital  goods,  demand  for,  23. 
Capitalization  defined,  21. 
Cash,  value  of,  254-256. 
Certification,  Wall  Street,  383. 
Checks,  title  to  deposited,  308. 
Circulation,  rapidity  of,  73. 
Civil  War, 

Financing,  226-227. 

Prices,  104. 

Clearing  house  principle,  121. 
Cleveland,  in  panic  of  1893,  178-182. 
Cognizability,  a  requisite  of  money, 

42. 
Coinage, 

Earliest,  46. 

History  in  United  States,  56-63. 

Requirements  of  good,  47. 
Contracts,  payment  of,  75. 
Coins, 

Fraudulent  depreciation  of,  47-48. 

Origin  of  names,  46. 
Collateral,   restrictions  on,  384. 
Collateral  loans, 

Details  of,  383. 

For  banks,  329. 

Merchandise,  329-336. 

Risk  in,  404. 
Collections, 

English  method  of,  301-302. 

Laws  of,  297. 

Out  of  town,  300. 
Commerce,  foreign,  131. 
Commercial  Banking,  foundation  of, 

195. 

Commercial  Banks,  plan  for,  387. 
Commercial  paper, 

Dealer  in,  343-344. 

Demand  and  supply  of,  342. 

Double-name,  321. 

Houses,  201. 

Single-name,  321. 

Size  of  notes,  345. 
Convertibility,  influence  on  value  of 

money  and  credit,  16. 
Commodity,    acceptability    for    ex- 
change, 41. 
Concealed  assets,  264. 


Cost    of    production,    determination 

of  value,  31. 
Credit, 

Analysis  of,  248. 

Bank,  202-208  (see  Bank  Credit). 

Bank  a  dealer  in,  233. 

Cancellation  of,  212. 

Convertibility  the  essence  of  value 
of,  16. 

Creation  by  bank,  249-251. 

Dangers  in  panics,  208. 

Defined,  15,  193. 

Deposit,  203-206. 

Exchange  by,  14. 

Gold  the  basis  of,  208. 

Importance  of,  209. 

Indirect  barter,  16. 

Kinds  of,  193. 

Letters  of,  145-146. 

Liquidation  of,  200. 

Necessity  of,  426. 

Non-circulating,  211. 

Operation  of,  16. 

Prices  affected  by,  211-219. 

Settlement  of  balances  by  use  of, 
122. 

Speculation  and,  216-217. 

Sources  of  information,  337-339. 

Use  in  industry,  194. 

Usefulness  in  exchange,  14. 
Credit  Agencies,  339. 
Credit  money, 

Argument  for,  224. 

Classified,  220. 

Defined,  221. 

Devices  to  maintain  value  of,  224. 

Difficulty  of  adjusting  supply  of, 
225. 

Factors  determining  value,  221. 

Prejudices    against    before    1861, 
226. 

Prices  affected  by,  215. 

Regulation  of,  222-224. 

Risk  in  free  use  of,  999. 
Currency, 

Cause  of  depredated,  18. 

Comptroller  of,  367 


490 


INDEX 


Credit,  220-230  (see  Credit 
Money). 

Defects  of  United  States,  217-219. 

Deposit,  212  (see  Deposit  Cur- 
rency). 

Elasticity  of,  419. 

Media  of  exchange,  15. 

Relation  to  capital,  22. 

Requirements  of  ideal,  419-422. 

Situation  in  1890,  176. 

Sub-Treasury  system,  420. 

Seasonal  demands  for,  373. 

Shipments  of,  117. 

United  States,  420. 


Debt, 

Demand,  229. 

Government,  227-229. 

Provisions  for  retiring,  230. 
Deferred  Payments, 

Defined,  65. 

Gold  as  standard  of,  64. 
Demand,  denned,  71. 
Demand  for  money, 

Discrimination  in,  79. 

Factors  influencing,  73-77. 

International  trade,  80. 

Seasonal,  80, 

Uncertainty  of,  81. 
Demand  sterling,  138-139. 
Depreciation,  of  currency,  18. 
Deposit,  nature  of,  256. 
Deposit  Currency, 

Development  of,  371. 

Inelasticity  of,  375. 

Liquidation,  372. 
Depositors, 

Inducements  of  bank  to,  304-306. 

Protection  of,  309-312. 
Deposits, 

General,  303. 

Government,  374. 

Guarantee  of,  378-380,  422. 

Special,  303. 
Desire,  denned,  71. 


Divisibility,  a  requisite  of  money,  41. 
Division  of  Labor, 

Business  the  result  of,  5. 

Effect  on  demand  for  money,  73. 
Discounts,  264. 
Dollar, 

Denned,  29. 

Fifty-cent,  186. 
Domestic  Exchange,  112-123. 
Dredging,  gold,  161. 


£ 


Economic  Forces, 

Cumulative  effect  of,  93. 

Prices  governed  by,  107-109. 

Value  a  register  of,  27. 
Economic  goods,  kinds  of,  18. 
Economics,  definition  of,  4. 
Elasticity, 

Canadian  currency,  411. 

Currency,  419. 
England, 

Bank  of  (see  Bank  of  England). 

Adoption  of  gold  standard,  53. 

Experience  with  double  standard 

of  value,  52-53. 
Entrepreneur, 

Effect  on  credit,  194. 

System  of  production,  19. 
European    Banking    Systems,    395- 

418. 
Exchange, 

Barter  state  of,  12. 

Beginning  of,  11. 

By  credit,  14. 

By  money,  12. 

Domestic,  112-122. 

Early  mediums  of,  11. 

Foreign,  122-152  (see  Foreign  Ex- 
change) . 

German  and  French,  149-151. 

Methods  of,  11. 

Money  a  factor  in,  13. 

New  York,  114-115. 

Value  of,  7. 


INDEX 


491 


Exchangeability, 

Utility   of   money   dependent   on, 

29. 

Exchange  utility,  35. 
Falkner  price  table,  100-104. 
Feudal  Period,  metals  in,  154. 
Fiat  money,  denned,  220. 
Fifty  cent  dollar,  186. 
Financial  banks,  plan  for,  388. 
Finance  bills, 

Defined,  140. 

Profit  on,  141-143. 
Foreign  commerce,  131-132. 
Foreign  Exchange, 

Dealer  in,  123. 

Gold  point,  127-8. 

Investment  buying  of,  147. 

Market  articles,  135-136. 

Quotations,  125. 

Speculation  in,  137. 

Varieties,  138. 
France, 

Banking  in,  401. 

Bank     of,     402     (see     Bank    of 

France). 
Free  Silver, 

Analysis  of  question,  182. 

Arguments  against,  186. 

Arguments  for,  184-185. 

Origin  of  movement,  183. 

Probable  results  of,  187-190. 

Solution  of  question,  190. 
Free  Silver  Party,  30. 


G 


Garnishment,  335. 
Germany, 

Imperial  Bank  of,  406-409. 
Gold, 

California,  158. 

Credit  an  influence  on  use  of,  199. 

Defects   as  standard   of  deferred 
payment,  64. 

Demand  for,  75. 

Discovery  of  in  California,  157. 

Good  qualities  as  money,  44. 


Market  for,  129. 

Mining,  160-163. 

New,  87-88. 

Objections  to  use  as  money,  45. 

Origin  of,  159. 

Premium  on,  81. 

Price  raising  effect  of,  87. 

Production  of,  159. 

Shipments,  131. 

Sources  of,  194. 

South  African,  159. 

Standard  of  value,  29. 

Supply  of,  83-85,  86. 

World's  stock  of,  153. 
Gold  exchange  standard  in  Mexico, 

191-192. 

Gold  Reserve  in  Panic  of  1893,  177. 
Gold  certificates,  220. 
Gold  point, 

Maximum,  127. 

Minimum,  127. 

Gold  standard,  United  States  adop- 
tion of,  61. 
Government     credit     money      (see 

Credit  Money). 
Government  debt,  227-229. 
Goods, 

Consumption,  18. 

Production,  18. 
Greenback  party,  168. 
Greenbacks,  66. 
Gresham's  Law,  50-51. 


H 


Hamilton,  Alexander,  56,  57,  68. 
Hoarding, 

Decline  of,  77. 

Government,  78. 


Imperial  Bank   (see  Bank  of  Ger- 
many). 
Income, 
Saved,  24. 


492 


INDEX 


Incomes, 

Money,  23. 

Sources  of,  23. 
Industrial  system, 

Relation   of  money   and   banking 

to,  10. 

Industries,  productive,  231. 
Industry, 

Credit  influences  on,  249. 

Integration,  10. 

Inelasticity,  present  currency,  375. 
Inflation,  Early  attempts,  167. 
Investing,  109. 
Investment, 

Defined,  24. 

Methods  of,  26. 

Real,  25. 


Jackson,  Bank  opposed  by,  355. 


Kiteing,  307. 


Labor, 

Division  of,  5,  9. 

Ideal  division  of,  9. 
Labor  Union,  169-171. 
Legal  tender,  55-56. 
Legal  tender  Acts, 

Of  1862-1863,  60. 
Legal  tender  laws, 

Constitutionality  of,  66. 

Effect  of,  66. 

Legislators,  mistakes  of  early,  51. 
Letters  of  Credit, 

Travelers,  145-146. 
Loan  clerk,  responsibilities  of,  385. 
Loans, 

Call,  326. 

Cash,  254. 

Credit,  254. 

Capital,  318. 

Collateral,     324     (see     Collateral 
loans). 


Demand,  321. 
In  Bank  Statement,  261. 
Industrial,  316-318. 
Investment,  315. 
Mortgage,  319. 
Classified,  315-320. 
London  settlement,  136. 

M 

Margin,  defined,  33. 

Marginal  utility,  32,  33. 

Market,  gold,  129. 

Medium  of  Exchange,  requirements 

of,  40-43. 
Merchandise,    collateral    for    loans, 

329-336. 

Metal,  standard  of  value,  48-49. 
Metals, 

As  money,  44. 

Precious,  153-163. 
Mexico,  gold  exchange  standard  in, 

191-192. 
Mining, 

Dredging,  161. 

Placer,  160. 

Quartz,  161-163. 
Mintage,  54. 
Money, 

Amount  necessary,  90. 

As  agent  of  production,  9. 

Convertibility  the  essence  of  value 
of,  16. 

Credit,  72. 

Demand  for,  73  (see  Demand  for 
Money). 

Fiat,  72. 

Forms  of,  11. 

Indirect  barter,  13. 

Instruments     in     production     of 
wealth,  10. 

Metals  as,  44. 

Platinum  used  as,  45. 

Primitive  forms  of,  36-40. 

Reasons  for  the  study  of,  1. 

Represents    incomplete    exchange5 
13. 


INDEX 


493 


Requisites  of  commodities  used  as, 
40-43. 

Short  sales  of,  95. 

Standard,  72. 

Supply  of,  S3,  85. 

Utility  of,  13,  71. 

Varieties  of,  72-73. 

United  States  varieties  of,  83. 
Money  and  Banking,  relation  to  in- 
dustrial system,  10. 
Money  and  Credit, 

Facilitate  exchange,  17. 

Representatives  of  wealth,  16. 
Mortgages,  196. 


N 


Nash, 

(President  Corn  Exchange  Bank), 

quoted,  331. 
National  Bank  Act,  365. 

Early  History  of,  366. 

Summary  of,  367-369. 
National  Bank  notes,  213. 
National  banking  system, 

Lack  of  unity  in,  377. 

Present  conditions  of,  371-380. 
National  Banks, 

Classes  necessary,  427. 

Defined,  280. 

Technical  powers  of,  368. 
New  York  Exchange,  114,  118. 
New  York  Stock  Exchange,  383. 
Note, 

Judgment,  323. 

Collateral,  323. 
Note  broker,  341. 
Notes, 

Circulating,  369-370. 


Overcapitalization   defined,   265. 
Overdrafts,  265. 


Panic, 

Of  1893,  172-174. 

Rich  man's,  386. 

Warnings  of  1907,  3. 
Paper  standard,  60-61. 
Placer  mining,  160. 
Platinum, 

As  money,  45. 

Political  Economy,  defined,  3. 
Population,    effect    on    demand    for 

money,  73. 

Postal  Savings  banks,  378. 
Pound  sterling,  125. 
Precious  metals, 

History  of,  153-163. 
Premium,  gold,  81. 
Price, 

Changes,  91-94. 

Defined,  69. 
Prices, 

Credit  an  influence  on,  211-219. 

Reserves  in  relation  to,  386. 

Speculation  an  influence  on,  216- 
217. 

Dependent    upon    money    market, 
70. 

Civil  War,  104. 

Economic   forces   governing,   107- 
109. 

Theory  of,  95-111. 
Price  tables,  97-107. 

Weighting  of,  99. 

Falkncr,  100. 

Foreign,  106. 

Comparison,  105. 
Private  banks,  280. 
Pheidon,  coinage  attributed  to,  46. 
Production, 

By  change  of  ownership,  6. 

Cooperative  system,  19. 

Defined,  5. 

Entrepreneur  system,  19. 
Productive  industries,  231. 
Profit,  defined,  27. 


494 


INDEX 


Property, 

Defined,  8. 

Insecurity  of,  76. 
Pyramiding,  386. 

R 

Ratio,  silver  to  gold,  56-60. 
Receipts,  Warehouse  (see  Warehouse 

receipts). 

Reichsbank,  406   (see  Bank  of  Ger- 
many) . 
Reserve, 

Amount  necessary,  256. 

Bank,  207. 

Methods  of  increasing,  257. 

Reasons  why  decreased,  257. 

Secondary,  258. 

Unreliability  of  bonds  as,  259. 
Reserves, 

Currency,  421. 

Depletion  of,  374. 

Prices  in  relation  to,  386. 

Redepositing,  386-387. 
Resources,   alterations   in   value  of, 

263. 
Ridgely,  opinion  of  Comptroller,  292. 


Safety  deposit  vaults,  304, 
Saving,  109. 
Savings  bank,  285. 
Savings  banks, 

Postal,  378. 

Present  conditions  of,  377. 
Securities, 

Dealers  in,  382. 

Market  in  United  States,  381. 

Undigested,  385. 
Secretary  of  Treasury, 

Expedients  of,  393. 

Responsibility  of,  390. 

Requirements  of,  392. 
Selling, 

Forced,  96. 
Set-off,  312,  313. 


Settlement,  London,  136. 
Sherman  Act,  172. 

Repeal  of,  178. 
Shipments,  gold,  131. 
Shorts,  squeezing,  95. 
Short  sales,  95. 

Silver  certificates,  175-176,  220. 
Silver  party,  90. 
Silver  Purchase  Acts,  172. 
Silver  question,   182    (see  Free  Sil- 
ver). 
Silver, 

Demonetization  of,  168. 

Demonetization  by  United  States, 
171. 

Effect  of  American,  156. 

Free  (see  Free  Silver). 

Good  qualities  as  money,  44. 

Objections  to,  45. 
Speculation,  425. 

Credit  an  influence  on,  216. 
Stability, 

Requisite  of  money,  42. 
Standard  of  value, 

Appreciating,  68. 

Double,  49,  52-53. 

Gold  in  United  States,  61. 

Metallic  money  as,  48. 

Paper,  60-61. 
State  Banks, 

Defined,  280. 

Evils  of,  423. 
Statement,  Bank,  260-270  (see  Bank 

Statement). 

Stock  Exchange,  New  York,  383. 
Stocks,  133. 
Sub-Treasuries, 

Settlement  of  banks  through,  117. 
Sub-Treasury  currency  system,  420. 
Suffolk  Bank  System,  357-358. 
Supply,  money,  82,  85. 
Surplus,  bank,  273-275. 


Trust  Companies, 
Defined,  282. 


INDEX 


495 


Deposits  of,  383. 
Erils  of,  433. 
Trust  Department  of,  383. 
Trusts, 

Corporate,  384. 
Individual,  384. 
Tobacco  as  money,  38. 
Tourists,  effect  on  foreign  exchange, 

134. 

Trade,  influence  of  money  on,  13. 
Treasury,  Secretary  of    (see  Secre- 
tary of  Treasury)  United  States 
(see  U.  S.  Treasury). 


U 


Underwriting,  381. 

Uniformity,  a  requisite  of  money,  41. 

United  States, 

Currency,  430. 

First  Bank  of,  350-352. 

History  of  coinage,  56-63. 

Second  Bank  of,  353. 
United  States  bonds,  in  Bank  State- 
ment, 366. 
United   States   money,  varieties   of, 

83. 

United  States  Steel  Corporation,  9. 
United  States  Treasury, 

Banks  in  relation  to,  390-394. 

Stringency  caused  by,  391. 
Usury  laws,  335. 
Utility, 

Exchange,  35. 

Extra  exchange,  13. 

Marginal,  33,  33. 

Theory  of  value,  31. 


Value, 
Attended  by  changes  in  price  of 

gold,  30. 

Cost  of  production  theory,  31. 
Defined,  37. 
Determination  of,  31. 
Gold  not  an  ideal  standard  of,  39. 
Price  distinguished  from,  38. 
Primitive  ideas  of,  38. 
Stability  of,  a  requisite  of  money, 

43-43. 

Store  of,  75. 
Utility  theory  of,  31. 

W 

Wampum, 
Use  as  money,  36. 
Defects  of,  43. 
Wall  Street,   Banks  in  relation  to, 

381-389. 

Warehouse  receipts, 
Law  of,  333. 
Loans  on,  333. 
Penalty  for  illegal  use,  335. 
Protection  to  holders  of,  334. 
Safeguarding  of,  334. 
Wealth, 

Banking  an  institution  in  produc- 
tion of,  10. 
Classified,  18. 
Definition  of,  4,  8. 
Money  an   instrument  in   produc- 
tion of,  10. 


THE  LIBRARY 
UNIVERSITY  OF  CALIFORNIA 

Santa  Barbara 


THIS  BOOK  IS  DUE  ON  THE  LAST  DATE 
STAMPED  BELOW. 


Series  !i  ls-J 


UC  SOUTHERN  REGlONALUBWflYFACjUrV 


A    000735381     6 


